TiEcon 2007

May 18-19, 2007
Table of Contents

Tab
2007 Update to Guide to Starting a Corporation........................................... 1
Financing Basics - Presentation Slides ........................................................2
Model Preferred Stock Financing Term Sheet (including Sample
Series A Preferred Stock Financing Analysis) ...............................................3
Venture Capital for High Technology Companies..........................................4
VC Terms Survey (Q4,2006) and Explanation of Terms.................................. 5
Software Escrows as Part of an Intellectual Property Strategy.......................6
Legal FAQ: Introduction to Patent Law ......................................................... 7
Developing a Patent Strategy - A Checlist for Getting Started........................8
About Fenwick & West LLP ..........................................................................9
Your Meeting Notes .................................................................................. 10

The contents of this publication are not intenteded, and cannot be considered, as legal advise or opinion

2007 Update to Guide to Starting a Corporation
fred m. greguras

About the Firm
Fenwick & West LLP provides comprehensive legal services to high technology and
biotechnology clients of national and international prominence. We have over 250 attorneys and
a network of correspondent firms in major cities throughout the world. We have offices
in Mountain View and San Francisco, California.
Fenwick & West LLP is committed to providing excellent, cost-effective and practical legal
services and solutions that focus on global high technology industries and issues. We
believe that technology will continue to drive our national and global economies, and look
forward to partnering with our clients to create the products and services that will help build
great companies. We differentiate ourselves by having greater depth in our understanding
of our clients’ technologies, industry environment and business needs than is typically expected
of lawyers.
Fenwick & West is a full service law firm with nationally ranked practice groups covering:
n

Corporate (emerging growth, financings, securities, mergers & acquisitions)

n

Intellectual Property (patent, copyright, licensing, trademark)

n

Litigation (commercial, IP litigation and alternative dispute-resolution)

n

Tax (domestic, international tax planning and litigation)

Corporate Group
For 30 years, Fenwick & West’s corporate practice has represented entrepreneurs, high
technology companies and the venture capital and investment banking firms that finance
them. We have represented hundreds of growth-oriented high technology companies from
inception and throughout a full range of complex corporate transactions and exit strategies.
Our business, technical and related expertise spans numerous technology sectors, including
software, Internet, networking, hardware, semiconductor, communications, nanotechnology
and biotechnology.

Our Offices
801 California Street

555 California Street, 12th floor

950 W. Bannock Street, Suite 850

Mountain View, CA 94041

San Francisco, CA 94104

Boise, ID 83702

Tel: 650.988.8500

Tel: 415.875.2300

Tel: 208.331.0700

Fax: 650.938.5200

Fax: 415.281.1350

Fax: 208.331.7723

For more information about Fenwick & West LLP, please visit our Web site at: www.fenwick.com.
The contents of this publication are not intended, and cannot be considered, as legal advice or opinion.

Guide to Starting a Corporation
Introduction....................................................................................................................... 1
A. Selecting the Form of Business Organization.................................................................. 1
1. Corporation........................................................................................................... 1
2. Sole Proprietorship...............................................................................................3
3. General Partnership..............................................................................................3
4. Limited Partnership...............................................................................................4
5. Limited Liability Company.....................................................................................4
B. S Corporations................................................................................................................4
C. Choosing a Business Name.............................................................................................5
D. Selecting the Location for the Business..........................................................................5
E. Qualifying to do Business in Another State.....................................................................6
F. Initial Capital Structure....................................................................................................6
1. Structure...............................................................................................................6
2. Minimum Capital ..................................................................................................7
3. Legal Consideration...............................................................................................7
4. Valuation..............................................................................................................7
5. Use of Debt.......................................................................................................... 8
6. Vesting and Rights of First Refusal....................................................................... 8
G. Sales of Securities..........................................................................................................9

Introduction
This guide describes certain basic considerations and costs involved in forming a Delaware
or California corporation. Although Delaware and California law are emphasized, the legal
concepts are much the same in other states. One important tip is that you should avoid
making business decisions in a vacuum. Instead, consider how a decision may impact
future alternatives. For example, an improperly priced sale of common stock to founders
immediately followed by a sale of preferred stock may result in a significant tax liability to the
founders. Another example is that converting a limited liability company into a corporation
immediately before the business is acquired, rather than at an earlier time, may prevent the
transaction from being tax-free.
This guide is only an overview, particularly as to tax issues and cannot substitute for
a professional advisor’s analysis and recommendations based on your individual fact
situations when establishing your business.

A. Selecting the Form of Business Organization
No single factor is controlling in determining the form of business organization to
select, but if the business is expected to expand rapidly, a corporation will usually be
the best alternative because of the availability of employee incentive stock plans; ease
of accommodating outside investment and greater long-term liquidity alternatives for
shareholders. A corporation also minimizes potential personal liability if statutory formalities
are followed. The characteristics of a corporation are described below, followed by an
overview of other traditional forms of business organizations. Each of the following factors
is described for comparison purposes: statutory formalities of creation, tax consequences,
extent of personal liability of owners, ease of additional investment, liquidity, control and
legal costs.
1. Corporation
A corporation is created by filing articles of incorporation with the Secretary of State in
the state of incorporation. Corporate status is maintained by compliance with statutory
formalities. A corporation is owned by its shareholders, governed by its Board of Directors
who are elected by the shareholders and managed by its officers who are elected by the
Board. A shareholder’s involvement in managing a corporation is usually limited to voting
on extraordinary matters. In both California and Delaware, a corporation may have only one
shareholder and one director. A president/CEO, chief financial officer/treasurer and secretary
are the officer positions generally filled in a startup and, in fact, are required under California
law. All officer positions may be filled by one person.
The reasons for using a Delaware corporation at startup are the ease of filings with the
Delaware Secretary of State in financings and other transactions, a slight prestige factor
in being a Delaware corporation and avoiding substantial reincorporation expenses later,

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since many corporations which go public reincorporate in Delaware at the time of the IPO.
Delaware corporate law benefits are of the most value to public companies. However, if
the corporation’s primary operations and at least 50% of its shareholders are located
in California, many provisions of California corporate law may be applicable to a private
Delaware corporation and such a company would pay franchise taxes in both California and
Delaware. These considerations may result in such a business choosing to incorporate in
California instead of Delaware. Another reason for keeping it simple and using a California
corporation is the current non-existent IPO market which makes an acquisition a more likely
exit for a start-up.
There is more flexibility under Delaware law as to the required number of Board members.
When a California corporation has two shareholders, there must be at least two Board
members. When there are three or more shareholders, there must be at least three persons
on the Board. Under Delaware law, there may be one director without regard for the number
of stockholders. Most Boards stay lean and mean in number as long as possible to facilitate
decision-making. Since the Board is the governing body of the corporation, when there are
multiple board members, a party owning the majority of the shares can still be outvoted on
the Board on important matters such as sales of additional stock and the election of officers.
Removing a director involves certain risks even when a founder has the votes to do so. Thus,
a founder’s careful selection of an initial Board is essential. You want board members whose
judgment you trust (even if they disagree with you) and who can provide you with input you
won’t get from the management team.
A corporation is a separate entity for tax purposes. Income taxed at the corporate level is
taxed again at the shareholder level if any distribution is made in the form of a dividend. The
S Corporation election described below limits taxation to the shareholder level but subjects
all earnings to taxation whether or not distributed. The current maximum federal corporate
tax rate is 35%. The California corporate income tax rate is 8.84% and the Delaware corporate
income tax rate is 8.7% but Delaware income tax does not apply if no business is done in
Delaware and only the statutory office is there. There is also a Delaware franchise tax on
authorized capital which can be minimized at the outset but increases as the corporation has
more assets.
If the business fails, the losses of the initial investment of up to $1 million in the aggregate
(at purchase price value) of common and preferred stock (so-called “Section 1244 stock”)
may be used under certain circumstances by shareholders to offset a corresponding amount
of ordinary income in their federal income tax returns. An individual may deduct, as an
ordinary loss, a loss on Section 1244 stock of up to $50,000 in any one year ($100,000 on a
joint return).
If statutory formalities are followed, individual shareholders have personal liability only to
the extent of their investment, i.e., what they paid for their shares. If the corporation is not
properly organized and maintained, a court may “pierce the corporate veil” and impose
liability on the shareholders. Both California and Delaware law permit corporations to limit
the liability of their directors to shareholders under certain circumstances. The company can 
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raise additional capital by the sale and issuance of more shares of stock, typically preferred
stock when an angel or venture capitalist is investing. Though rare, the power of a court to
look through the corporation for liability underscores the importance of following proper
legal procedures in setting up and operating your business.
Filing fees, other costs and legal fees through the initial organizational stage usually total
about $3,500 to $5,000, with a Delaware corporation being at the high end of the range.
2. Sole Proprietorship
The simplest form of business is the “sole proprietorship,” when an individual operates a
business on his own. The individual and the business are identical. No statutory filings are
required if the sole proprietor uses his own name. If a different business name is used in
California, a “fictitious business name” statement identifying the proprietor must be filed
with the county clerk of the county where the principal place of business is located and
published in the local legal newspaper. A sole proprietor has unlimited personal liability to
creditors of his business and business income is taxed as his personal income. Because of
the nature of this form of business, borrowing is the usual method of raising capital. The
legal cost of forming a sole proprietorship is minimal.
3. General Partnership
When two or more individuals or entities operate a business together and share the
profits, the enterprise is a “partnership.” Partnerships are either general partnerships or
limited partnerships (described below). Although partners should have written partnership
agreements which define each party’s rights and obligations, the law considers a venture
of this type as a partnership whether or not there is a written agreement. No governmental
filings are required for a general partnership. A partnership not documented by a written
agreement is governed entirely by the versions of Uniform Partnership Act in effect in
California and Delaware.
In the absence of an agreement to the contrary, each partner has an equal voting position in
the management and control of the business. Each partner generally has unlimited liability
for the debts of the partnership and is legally responsible for other partners’ acts on behalf
of the business, whether or not a partner knows about such acts.
The partnership is a conduit for tax purposes: profits (even if not distributed) and losses
flow through to the partners as specified in the partnership agreement. There is no
federal tax at the entity level. Some partnerships contemplate raising additional capital,
but accommodating future investment is not as easy as in a corporation. The legal cost of
establishing a partnership is minimal if no formal written agreement is prepared but not
having a written agreement may cause disputes over the economic benefits, intellectual
property and assets of the partnership. The cost of preparing such an agreement begins at
about $2,000 and depends on the number of partners, sophistication of the deal and other
factors.

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4. Limited Partnership
This is a partnership consisting of one or more general partners and one or more limited
partners which is established in accordance with the California and Delaware versions of
the Uniform Limited Partnership Act. Like the corporation, this entity has no legal existence
until such filing occurs. The limited partnership is useful when investors contribute money
or property to the partnership but are not actively involved in its business. The parties
who actively run the business are the “general partners,” and the passive investors are
the “limited partners.” So long as the limited partnership is established and maintained
according to statutory requirements, and a limited partner does not take part in the
management of the business, a limited partner is liable only to the extent of his investment.
Like a general partnership, however, the general partners are personally responsible for
partnership obligations and for each other’s acts on behalf of the partnership.
For tax purposes, both general partners and limited partners are generally treated alike.
Income, gains and losses of the partnership “flow through” to them and affect their
individual income taxes. A properly drafted limited partnership agreement apportions
profits, losses and other tax benefits as the parties desire among the general partners
and the limited partners, or even among various subclasses of partners subject to certain
requirements imposed by U.S. tax law, i.e., the Internal Revenue Code (the “IRC”).
5. Limited Liability Company
This form of business organization is available in Delaware and California as well as many
other states. It is essentially a corporation which is taxed like a partnership but without many
of the S Corporation restrictions identified below. An LLC has fewer statutory formalities
than a corporation and is often used for a several person consulting firm or other small
business. An LLC does not provide the full range of exit strategies or liquidity options as does
a corporation. It is not possible to grant stock option incentives to LLC employees in the same
manner as a corporation. Further, an acquisition of an LLC generally may not be done on a
tax-free basis and the expenses of formation are higher than for forming a corporation.

B. S Corporations
A corporation may be an “S corporation” and not subject to federal corporate tax if
its shareholders unanimously elect S status for the corporation on a timely basis. “S
corporation” is a tax law label; it is not a special type of corporation under state corporate
law. Like a partnership, an S corporation is merely a conduit for profits and losses. Income is
passed through to the shareholders and is generally taxed only once. Corporate level tax can
apply in some circumstances to an S corporation that previously had been a “C” corporation
for income tax purposes. Losses are also passed through to offset each shareholder’s income
to the extent of his basis in his stock and any loans by the shareholder to the S corporation.
The undistributed earnings retained in the corporation as working capital are taxed to a
shareholder. 

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A corporation must meet certain conditions in order to be an S corporation, including the
following: (1) it must be a U.S. corporation, (2) it must have no more than 100 shareholders,
(3) each shareholder must be an individual, certain trusts, certain charitable organizations,
employee stock ownership plans or pension plans, (4) no shareholder may be a nonresident
alien, and (5) it can have only one class of stock outstanding (as opposed to merely being
authorized). As a result, S corporation status will be terminated when a corporation sells
preferred stock or sells stock to a venture capital partnership, corporation or to an off-shore
investor.
California and Delaware recognizes the S corporation for state tax purposes, which may
result in additional tax savings. California, however, imposes a corporate level tax of 1.5%
on the S corporation’s income and nonresident shareholders must pay California tax on
their share of the corporation’s California income. In addition, only C corporations and
noncorporate investors are eligible for the Qualified Small Business Corporation capital gains
tax break. The benefit of this tax break is that if the stock is held for at least 5 years, 50% of
any gain on the sale or exchange of stock may be excluded from gross income. This benefit
may not be as important because of the reduction in the capital gains tax rate.

C. Choosing a Business Name
The name selected must not deceive or mislead the public or already be in use or reserved.
“Inc.,” “Corp.” or “Corporation” need not be a part of the name in California but must be part
of a Delaware corporate name. Name availability must be determined on a state-by-state
basis through the Secretary of State. A corporate name isn’t available for use in California
merely because the business has been incorporated in Delaware. Several alternative names
should be selected because so many businesses have already been formed. Corporate name
reservation fees range from approximately $10-50 per state for a reservation period of 30-60
days. Exclusive state rights in a trade name can also be obtained indefinitely through the
creation of a name-holding corporation, a corporation for which articles of incorporation are
filed but no further organizational steps are taken.

D. Selecting the Location for the Business
This decision is driven by state tax considerations and operational need, for example, to be
near customers or suppliers or in the center of a service territory. A privately-held corporation
cannot avoid California taxes and may not be able to avoid the application of California
corporate law if it is operating here and has most of its shareholders here. For example,
Delaware law allows Board members to be elected for multiple year terms and on a staggered
basis rather than on an annual basis. A privately held corporation, however, may be able to
have the benefits of these Delaware laws or any other state’s corporate law if it is actually
operating in California and more than 50% of its shareholders are here.

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E. Qualifying to do Business in Another State
A corporation may need to open a formal or informal office in another state at or near the
time of founding. This requires a “mini” incorporation process in each such state. If a
California business is incorporated in Delaware it must qualify to do business in California.
The consequences of failing to do so range from fines to not being able to enforce contracts
entered in that state. The cost of qualifying is approximately $1,000 per state. Some states,
like Nevada, also charge a fee based on authorized stock, so the fee could be higher in such
states.

F. Initial Capital Structure
1. Structure
The capital structure should be kept as simple as possible and be within a range of
“normalcy” to a potential outside investor for credibility purposes. A common initial
structure is to authorize 10 million shares of common stock and 4 million shares of preferred
stock. Not all authorized shares of common stock are sold at the founding stage. After initial
sales to founders, there are usually only about 3-5 million shares issued and outstanding and
about 1-2 million shares reserved in the equity incentive plan. This is referred to as the “1X
model” below.
While at the outset there may not seem to be any difference between owning 100 shares or
1 million shares, a founder should purchase all of the units of stock he desires at the time of
founding. Thereafter, a founder will generally lose control over further issuances and stock
splits, particularly once a venture capital financing occurs. In addition, the purchase price
will usually increase.
The number of shares issued and reserved in the initial capital structure are driven by a
desire to avoid a later reverse stock split at the time of an IPO because of excess dilution. The
number of shares outstanding at the time of an IPO is driven by company valuation at IPO,
the amount to be raised in the IPO and IPO price per share range (usually $10 to $15). The
“pattern” for the business value at the time of the IPO can be reached by forward or reverse
stock splits. For example, if a corporation has a market valuation at IPO time of $200 million,
it would not be feasible for 40 million shares to be outstanding. A reverse stock split is
needed. Reverse stock splits reduce the number of shares held. On the other hand, forward
stock splits add shares to holdings. Neither changes the percentage ownership, but seeing
the number of shares held decrease because of a reverse split is still hard on employee
morale.
Because of the great demand for engineers during the Internet bubble, many corporations
used a multiple of this 1X model in order to have more equity units available for employees.
The immediate need for employees to increase the possibility of business success
outweighed the potential consequence of a later reverse stock split. Currently, most startups
use a 1X or 2X model to avoid excessive dilution. 
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2. Minimum Capital
Neither Delaware nor California law require a minimum amount of money to be invested in a
corporation at the time of founding. The initial amount of capital, however, must be adequate
to accomplish the purpose of the startup business in order for shareholders not to have
personal liability. For example, a corporation which will serve only as a sales representative
for products or a consulting operation requires less capital than a distributor or dealer who
will stock an inventory of products. A dealership or distributorship will require less capital
than a manufacturing operation.
3. Legal Consideration
A corporation must sell its shares for legal consideration, i.e., cash, property, past services
or promissory notes under some circumstances. A founder who transfers technology or other
property (but not services) to a corporation in exchange for stock does not recognize income
at the time of the transfer (as a sale of such property) under IRC Section 351 if the parties
acquiring shares at the same time for property (as opposed to services) own at least 80%
of the shares of the corporation after the transfer. Because of this limitation, Section 351 is
generally available at the time of founding but not later. Since a party who exchanges past or
future services for stock must recognize income in the amount of the value of the stock in the
tax year in which the stock is received, it is the prefered practice to issue the shares at a low
valuation for cash or property.
4. Valuation
The per share value at the time of founding is determined by the cash purchases of stock
and the number of shares issued. For example, if one founder buys stock in exchange for
technology and the other founder buys a 50% interest for cash, the value of the technology
and the fair market value per share is dictated by the cash purchase since its monetary value
is certain. Sales of the same class of stock made at or about the same time must be at the
same price or the party purchasing at the lower price may have to recognize income on the
difference.
Thereafter, value is determined by sales between a willing seller and buyer or by the Board
of Directors based on events and financial condition. Value must be established by the Board
at the time of each sale of stock or grant of a stock option. Successful events cause value
to increase. Such determinations are subjective and there is no single methodology for
determining current fair market value. There are pitfalls of hedging on the timing of forming
corporation to save on expenses. The longer the delay in incorporating, the more difficult it is
to keep the founders price at a nominal level if a financing or other value event is imminent.
A general objective is to keep the value of common stock as low as possible as long as
possible to provide greater stock incentives to attract and keep key employees. Tax and state
corporate laws generally require option grants to be made at current fair market value. IRC
Section 409A has increased the diligence needed in determining pricing for stock option
grants.

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5. Use of Debt
Loans may also be used to fund a corporation. For example, if a consulting business is
initially capitalized with $20,000, half of it could be a loan and the remaining $10,000
used to purchase common stock. Using debt enables the corporation to deduct the interest
payments on the debt, makes the repayment of the investment tax free and gives creditor
status to the holder of the debt. If a corporation is too heavily capitalized with shareholder’s
loans, as opposed to equity (usually up to a 3-1 debt/equity ratio is acceptable), however,
these loans may be treated as additional equity for tax and other purposes. Debts owed
to shareholders may be treated as contributions to capital or a second class of shares and
subordinated to debts of other creditors. Eligibility for S corporation status is lost if a loan is
characterized as a second class of shares.
6. Vesting and Rights of First Refusal
Shares sold to founders are usually subject to vesting and rights of first refusal in order
to keep founders on the corporate team and to maintain control over ownership of the
corporation. Grants of options under an equity incentive plan also have such “stickiness”
restrictions. Such safeguards are essential to securing a venture capital investment. By
designing and implementing a reasonable vesting scheme themselves, founders may
forestall an investor from doing so on the investor’s terms. Vesting also assures investors
that the founders and others are committed to the corporation and not just looking for a
quick pay day. The corporation typically retains the option to repurchase unvested shares at
the initial purchase price at the time of termination of a shareholder’s employment. Vesting
usually occurs over 4 years, i.e., if the employee remains employed by the corporation for
the entire period, all shares become “vested” and the repurchase option ends. A common
pattern is for 25% of the shares to vest after 12 months and the remainder to vest monthly
over the next 36 months. Vesting is implemented by stock purchase agreements. An IRC
Section 83(b) election must be filed with the Internal Revenue Service by a party buying
unvested shares within 30 days of the date of purchase in order to prevent taxable income at
the times such shares vest.
A right of first refusal is the corporation’s option to repurchase shares when a third party
makes an offer to purchase shares. This type of restriction can be used by itself or as a
backup to the repurchase option to maintain control over stock ownership once vesting
occurs. The corporation may repurchase the shares on the same terms as the offer by the
third party. Rights of first refusal are implemented by stock purchase agreements, including
under stock option plans, or in the corporation’s bylaws. Rights of first refusal (but not rights
of repurchase on termination of employment) terminate upon an IPO or acquisition.

G. Sales of Securities
Offers and sales of stock in a corporation, certain promissory notes and loans, certain
partnership interests and other securities are subject to the requirements of the Securities
Act of 1933, a federal law, and of state securities laws, so-called “Blue Sky” laws. While
some state laws are preempted by federal securities laws in some cases, an offer or sale 
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of securities in multiple states generally requires compliance with each state’s law. The
general rule under these laws is that full disclosure must be made to a prospective investor
and that registration or qualification of the transaction with appropriate governmental
authorities must occur prior to an offer or sale. An investor can demand its money back
if securities laws are not followed. There are also severe civil and criminal penalties for
material false statements and omissions made by a business or its promoters in offering or
selling securities. Legal opinions regarding exemptions are not possible if securities are sold
without regard for such laws. An opinion may be required in venture capital investments or
an acquisition.
Exemptions from the registration and qualification requirements are usually available for
offers and sales to founders, venture capitalists and foreign parties but offers and sales to
other potential investors, even employees, are not legally possible without time consuming
and expensive compliance with such laws. State laws have relatively simple exemptions for
option grants and stock issuances under a formal equity incentive plan, which is why a plan
should be the source of equity for employees and consultants.
The stock purchased in a sale exempt from federal registration and state qualification
requirements will not be freely transferable. In addition to contractual restrictions, resales
must satisfy federal and state law requirements. Shareholder liquidity occurs through
Securities and Exchange Commission Rules 144 or 701, an IPO, other public offerings or other
exempt sales.

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TiE Institute – Legal Education
Series
February 21, 2007

Term Sheets and Early Stage
Financing Terms For Private
Companies
(Presentation Slides)

Samuel Angus
Fenwick & West LLP

Term Sheets and Early Stage Financing Terms
For Private Companies
Private Company Financing Types
1) Seed Financings
2) VC Financings:
„ Process and Overview
„ VC/Preferred Stock Model

3) Private Company Liquidation Exits
„ Acquisition Scenarios

4) Conclusion
2

Private Company Financings (Types)
„

Seed Financings

Founder

Friends, Family, Angels


Early Stage VCs
Type of Security – convertible notes/series A
Preferred Stock?

„

Venture Capital

„

Corporate Partner



„

Valuation
“Strings attached”

Debt Financing
3

1

Private Company Financings –
Founder Financing
„

Very early stage of the Company – Usually less than $250,000;
Types:

Note (simple debt)

Convertible Notes with a kicker (discount or warrant coverage)

Series A Preferred Stock (do not issue common stock)

Debt that converts into stock sold in a “qualified financing”

„

„

Advantages:

Founder initially gets to set terms

Founder can receive vested shares

Disadvantages:

Treatment of debt in next serious financing

Overreaching on terms of convertible notes/Series A Preferred
Stock

Valuation issues

4

Private Company Financings –
Angels/Friends & Family Financing
„

Generally between $250,000 to $1,500,000; Types:

• Convertible Notes with a “kicker” (discount or warrant
coverage)

– Discount off of the price of the Preferred Stock sold in a Qualified

Financing – Typically 10% to 30% discount

– Warrant coverage typically 10% to 30% depending on the

company and timing of the next financing

– Warrant Coverage Formula: Warrant to purchase X shares of

common stock, where X = (warrant coverage percentage x
principal amount note) ÷ conversion price of shares

– Warrant coverage percentage can be capped, and/or scale based

upon investment amount or how long the note is outstanding

• Series A Preferred Stock financing – More likely to get
company favorable terms, but:
– Future approval rights
– Valuation issues

5

Private Company Financings –
Early Stage VC Financing
„

Early stage VC seed investments
$500,000 to $2,000,000 range.

in

the

• Typical structure – convertible notes with a
kicker (discount or warrant coverage)

Often financing will include a right to lead the next
“qualified financing” at a certain minimum investment
level

The VC may also receive certain management rights
(such as a board seat, protective provision rights)
while the notes are outstanding

• Quick and results simple capital structure (one
or two investors)

• Can limit alternative investors on next financing

6

2

Private Company Financings –
Classic VC Financing
„

Classic VC Financing: Series A Preferred Stock
• Typical valuation ranges: $4.0 million to $10.0 million (prefinancing)

• Minimum ownership: 20% (post-financing, including option
pool), but can be higher if multiple VCs are involved (40%
to 60%)

• Other Key Terms:
–Liquidation Preference – Standard, 1x with participation
(capped)
–Board composition – Standard, 5 directors, with two common
(one of which is the CEO), two investor directors, and one
independent director
–Protective provisions – Standard, any change to rights of the
Series A Stock, merger/sale of the company, dividends, sale of
additional Preferred Stock
–Other terms – Anti-dilution protection, drag along rights, new
founder vesting

7

Venture Capital Financings –
VC/Preferred Stock Model
„

VC/Preferred Stock Model
• Cheap Common Stock (for Founders and Employees)
• Expensive Preferred Stock (for Investors)
• Investors Get Additional Rights to Hedge Operating and Financial
Risks

„

Privileges of Preferred Stock
• Liquidation and Dividend Preferences
• Voting (Board) Rights
• Protective Provisions (veto rights)
• Conversion Rights/Antidilution Protection
• Redemption
• Registration Rights
• Information Rights
• Participation Rights

8

Private Company Liquidation Exits
„

IPO – Unlikely at this time
• Public market currently very weak for tech companies
• Minimum market cap of $150 - $200 million
• Heightened regulatory requirements and costs

„

Acquisition – Most likely liquidity event for
private companies
• M&A market is strong, with large premiums being paid for
companies with large user/customer base and/or strong
products

• Faster liquidity/exit timing
• Subject to post-closing terms (escrows, earnouts, noncompetes, etc.)
9

3

Acquisition Scenarios
Company
Type
Founder
Financed
Angel Financed

Capitalization at Exit
„

Founder – 2,000,000 CS shares

„

Employees* – 500,000 CS shares

„

Founder – 2,000,000 CS shares

„

Employees* – 600,000 CS shares

Exit
Amount
$7.0M

Founder – $5.6M
Employees – $1.4M

$15.0M

Founder – $9.67M
Employees – $2.9M

Angels** – 333,333 PS shares +
66,667 CS shares (warrants)

Angels - $2.43M

„

VC Financed

Return on Exit

„

Founder – 2,000,000 CS shares

$50.0M

„

Employees* – 1,333,333 CS shares

Founder – $13.5M
Employees – $9.0M

„

VC*** – 3,333,333 PS shares

VC – $27.5M

Assumptions:
* Assumes 20% stock option pool at each exit.
** Assumes that the angels have previously invested $500K in the form of notes which converted
into shares of Series A PS (with same terms as the VC received below). Warrant coverage is 20%.
*** Assumes that the VC had previously invested $5.0 at a $5.0M pre-financing valuation into
shares of Series A PS with a 1x liq. pref. that fully participates with the CS.
10

Conclusion
„

Current financing environment strong and improving

• Valuations continue to improve (along with VC investment, which increased

to $6.4B (Q3’06), vs. $6.8B (Q2’06) and $6.0B (Q3’05) – on track for largest
investing year since 2001

• Web 2.0/Media space strong with large exits (YouTube, My Space)
• IPO market still weak for tech/web companies
• To build interest
–Demonstrate
–Show

„

large addressable market

Negotiate the important stuff, skip the small stuff





„

customers/revenue product achievement

company’s progress/milestones will be when the funding is spent

–Demonstrate

Valuation/Dilution, but don’t let it kill the deal
Liquidation Preferences
Protective Provisions
Board Control

Materials

• Fenwick & West Financing Materials
• Sample Venture Capital Term Sheet (annotated)
• Q3 2006 Quarterly Venture Capital Terms Survey & Glossary

11

Contact Information
Fenwick & West LLP
Samuel B. Angus, Partner,
Corporate and Venture Capital Group
Telephone: (415) 875-2440

email: sangus@fenwick.com

12

4

TiE Institute – Legal Education Series
February 21, 2007

Venture Capital Term Sheet
Fundamentals
(Detailed Slides)

Samuel Angus
Fenwick & West LLP

Venture Capital/Angel Term
Sheet Fundamentals
1) Seed Investing Overview
2) VC Financing: Process and Overview
3) Term Sheet Valuation Issues
4) Preferred Stock Privileges
5) Investor Protections and Rights
6) Stock Purchase Terms
7) Conclusion

2

Preparing Your Company
For Investment
„ Look “conventional”
„ Complete founders stock purchases
„ Founders should have vesting but with

acceleration provisions
„ Adopt California compliant stock option plan
„ Avoid previous employer and other IP issues

3

1

Private Company Financings (Types)
„ Seed Financings

Founder



Friends, Family, Angels
Early Stage VCs
Type of Security – convertible notes/series A Preferred
Stock?

„

Venture Capital

„

Corporate Partner

Valuation

“Strings attached”

„ Debt Financing?
„ Role of a Term Sheet
„ Securities Laws
4

Seed Stage Financings: Common Stock?
„

Pricing of common stock must be same for all sales at or about
the same time. Cannot grant options to employees for $0.01
and sell shares of common stock to seed investors for $1.00 at
the same time

„

Selling common stock is not generally used because of the
dilutive effect and impact on stock options

• Consider number of shares at $0.01 per share
needed to be sold to raise even $100!
„

Objective is to keep the common stock price low as long as
possible to motivate employees and other service providers
with stock options

„

Interplay of recent tax regulations on Common Stock valuation
(IRC 409A)

5

Seed Stage Financings:
Use Of Preferred Stock
„ Requires a pre-money valuation for the
company. Investors will buy a percentage
of the company
„ Series A round can be complicated and

expensive even if raising a small amount of
money. Cost may be disproportionate to
amount raised

„ Defer a preferred stock financing if possible

6

2

Seed Stage Financings: Convertible Notes
„

Issue convertible notes for “next financing”
preferred stock

„

Defers valuation decision and keeps the
financing simple and low cost

„

Discount on conversion rate (or warrants) is
often used as a “sweetener” for the investors to
take the risk

7

Venture Capital Financings
Process And Overview

Venture Capital Financings – Process & Timetable
„ Step 1: Meetings with Investors; Investor High-Level Due

Diligence

„ Step 2: Decision by Investor to invest
„ Step 3: Term Sheet negotiation (0-2 weeks)
„ Step 4: Financing Documentation and Diligence (4-6 weeks)

• Conduct legal and business due diligence
• Ascertain compliance with securities laws
• Draft definitive agreements (purchase agreement, Articles, voting
agreements)

• Prepare closing deliveries (Schedule of Exceptions, consents,
opinions, government filings)

„ Step 5: Sign and close
„ Step 6: Additional closings / Milestones (?)
8

Process And Overview
Preferred Stock Model [2]
„ VC/Preferred Stock Model

• Cheap Common Stock (for Founders and Employees)
• Expensive Preferred Stock (for Investors)
• Investors Get Additional Rights to Hedge Operating and
Financial Risks

„ Privileges of Preferred Stock

• Liquidation and Dividend Preferences
• Voting (Board) Rights
• Protective Provisions (veto rights)
• Conversion Rights/Antidilution Protection
• Redemption
• Registration Rights
• Information Rights
• Participation Rights

9

3

Term Sheet Valuation Issues [1, 3]
„ Context
„ Methodology for Valuation (Pre-Financing)

• Discounted Cash Flow
• Multiple of Revenues/Sales
• Multiple of Earnings
• Real World – Private Company Factors
– Customers
– Revenues / Earnings
– Product Development
– Management

„ How Much to Raise?
„ How is Per Share Price Calculated?

10

Term Sheet Valuation Issues
Definitions
“Outstanding Securities”= Issued Common and Preferred Stock,
options, warrants and convertible notes, and any other rights to
equity that have been granted and paid for
“Option Pool” = Options that have been reserved for issuance but have
not yet been granted
“Fully-Diluted Shares” (FDS) = Outstanding Securities plus Option Pool
“Pre-Money Valuation” = Set by Investor-Founder negotiation
“Per Share Price” = Pre-Money Valuation divided by FDS
“Post-Money Valuation” = Pre-Money Valuation plus New Money Raised
11

Term Sheet Valuation Issues
Valuation Example
Founders - 5,000,000 shares at $0.01 = $50,000 valuation
Option Pool Required = 2,500,000 shares
Pre-Money Valuation = $3,000,000
FDS Pre-Series A = 7,500,000 shares
Per Share Price = $3,000,000/7,500,000 shares = $0.40
Series A Investment = $4,000,000
Series A Stock Issued = $4,000,000/$0.40 = 10,000,000 shares
FDS Post-Series A = 17,500,000 shares
Founders 28.58%, Option Pool 14.28%, Investors 57.14%
Post-Money Valuation = $7,000,000
12

4

Preferred Stock Privileges
„ Liquidation Rights [6]
„ Conversion Rights [10, 11]
„ Pay to Play Provisions
„ Redemption Rights [7]
„ Dividends [5]
„ Protective Provisions [13]

13

Preferred Stock Privileges
Liquidation Rights [6]
„ Preference (Investors get “off the top”)

• Available for merger / acquisition / sale of assets (not just
liquidation)

• Return of initial investment BEFORE common holders get paid
„ Preferences Senior or Pari Passu with Other Series
„ Multiple Preference
„ Participation with Common (After Preference):

• None: Investors DO NOT share with Common
• Full Participation: Investors share PRO RATA with Common (as-if
converted)

• Capped Participation:

Investors share Pro Rata with Common
UNTIL [3x] return received

„ Investors can convert to common
14

Participating Preferred Example
Assume $3M preferred investment for 60% of Company

Sale of
Co. @

Pref. 1X

Common
(40%)

Pref. 2X

Common

$3M

$3M

0

$3M

0

$6M

$4.8M

$1.2M

$6M

0

$10M

$7.2M

$2.8M

$8.4M

$1.6M

$15M*

$10.2M*

$4.8M

$11.4M*

$3.6M

$25M

$16.2M

$8.8M

$17.4M

$7.6M

*If 3X cap., Preferred would max. out here
15

5

Preferred Stock Privileges
Conversion Rights [10, 11]
„ Optional Conversion

• Holders can convert to Common at any time
• Lose all rights of Preferred Stock
„ Automatic Conversion – must convert to Common if:

• “Approved” IPO ($10-20M)
• Majority (or 2/3) elect to convert (written)
„ Conversion Ratio (initially 1:1)

• Event-Based changes

Stock splits, stock dividends, reverse stock splits

– Retain same percentage ownership

• Price-Based changes (Dilutive Financing)

Anti-dilution Protection

– Pay to Play
16

Preferred Stock Privileges
Anti-dilution Protection [12]
„ Weighted Average

• Mechanics:
– Weights the difference in price (prior round and current)
by proportion of shares (pre-financing and post financing)
– The fewer the “new dilutive” shares sold (relative to
number in prior rounds) the less the reduction in
conversion price

• Narrow Based – include only Preferred shares

outstanding in count (or Preferred and Common)

• Broad Based – includes Preferred/Common

outstanding and granted options / warrants
(reduces effect of proportion)
17

Preferred Stock Privileges
Anti-dilution Protection [12]
„ Ratchet – reduce conversion price to new sale price

• Full Ratchet – very harsh
– Can cause great dilution for relatively few shares sold
at lower price

• Capped or Limited

Limit duration of ratchet, or extent

– Ratchet is removed upon completion of

performance targets

– Ratchet is removed upon subsequent non-dilutive
round
18

6

Preferred Stock Privileges
Anti-dilution Protection [12]
Carve-outs from Anti-dilution

• Options grants to employees, consultants (any vs. only for
authorized Pool)

• Warrants to lenders, equipment liens
– Any vs. limited amount
– Majority vs. unanimous board approval

• Warrants to service providers, suppliers, strategic partners
(any/limited, BOD approval)

• Shares issued in mergers / acquisition
• Exercises or conversions of current stock or grants
19

Preferred Stock Privileges
Pay to Play
„ Dilutive Financing (“down round”) Î
• Investor must purchase his pro-rata share
• otherwise:
– Investor loses all anti-dilution protection Îconvert
Investor’s Preferred Shares to Shadow Preferred
(without anti-dilution)
– Investor loses ALL Preferred Stock privileges Î
convert Investor’s Preferred Shares to Common
Stock

• Avoid “free riding” by non-paying investors
20

Preferred Stock Privileges
Redemption Rights [7]
„ Optional (Company Option: “Call”)

• Company can repurchase stock if Investors won’t convert to
Common (after x years)

„ Mandatory (Investor Option: “Put”)

• Investor can force Company to repurchase shares
– after [5-7] years – in installments over [3] years
– get liquidity if no public market
– But, Company must have funds legally available

• If not paid when due
– Investors may take over control of Board
– Resign / Replace board seats held by Common
21

7

Preferred Stock Privileges
Redemption Rights [7]
„ Redemption amount typically includes accrued,

unpaid dividends Æ Redemption Premium
„ Redemption price

• Original purchase price
• Premium return (FMV)

22

Preferred Stock Privileges
Dividends [5]
„ Preferred has Priority

• Preferred paid before Common (as-converted)
• Preferred may participate with Common
„ Discretionary vs. Mandatory

• Discretionary:

no obligation to pay ever

– “when, as and if declared by the Board”

• Mandatory:

must pay if legally available funds exist

„ Non-cumulative vs. Cumulative

• Non-cumulative:
• Cumulative:

disappears if not declared (not due)

unpaid dividends accrue (still due)

– Cumulate: annually, bi-annually, quarterly, or monthly

23

Preferred Stock Privileges
Dividends [5]
„ Watch out for Mandatory, Cumulative Dividends

• Dividend may be payable in cash, or in additional
preferred shares

• Accrued dividend may be added to liquidation
preference, if not paid when due

• Compounds effect of participating liquidation
preference

24

8

Preferred Stock Privileges
Protective Provisions [13]
„ Purpose: Requires the company to seek investor
approval before taking certain actions
„ Series vs. Class

• Class – need approval of [majority / some %] of all

holders of Preferred Stock (all series voting together)

• Series – need approval of [majority / some %] of all
holders of an individual Series

May need separate approvals from other Series

Terminate if Series holds less that minimum % of original
purchase (5-20%)

25

Preferred Stock Privileges
Protective Provisions [13]
„ Typical Preferred Stock approvals:

• Amend Articles / Certificate (or Bylaws)
– Alter /change rights, preferences of Series A
– [materially and] adversely affect Series A

• Reclassify outstanding securities into series senior or parity
with Series A

• Authorize new series – senior or parity to Series A
• Increase / decrease authorized shares Preferred Stock
• Merger / acquisition, sale of substantially all assets
• Liquidation / dissolution
• Declare or pay dividend
• Change authorized number of Board Directors
26

Key Control Terms
„ Founder / Employee Vesting
„ Board Representation
„ Preferred Protective Provisions

27

9

Control Terms
Vesting [24, 25]
„ Required by Investors to properly motivate the Employees
and Founder(s) and protect Investor’s investment.
„ Rank & File Employees [24]
• 4-year vesting: one year cliff and monthly thereafter.

„ Founder [25]
• X% fully vested upon Closing, a cliff period and monthly
thereafter for total of 4 years
• Change of Control & Termination without
Cause/Constructive Termination
28

Control Terms
Board Representation [9]
„ Representatives
• Company representative (CEO)
• Founder (if not Company representative)
• Preferred Stock Representatives (Investors)
• Independent Directors (industry specialist – appointed by all
outstanding stock or other board members) – key issue

„ Common Series A Board Makeup

• Founder, CEO, Series A Rep (3-person Board)
• Founder, Founder (CEO), Series A Rep, Series A Rep, Independent
Rep (5-person Board)

„ Non-Voting Board Observers
29

Investor Protections And Rights
„ Rights of First Refusal and Co-Sale Rights
„ Information Rights
„ Registration Rights

30

10

Investor Protections And Rights
Rights of First Refusal (ROFR) [14, 26]
„ New issuances by Company [14]
• Investor right to purchase shares in new round
• Up to pro-rata share of Company
• Carve-outs for certain sales/transfers

• Terminate: IPO, acquisition, sale of assets
„ Sales by Founders [26]
• Investor right to purchase Founder’s shares (take deal
offered by outside buyer to Founder)
• Keep stock “in the family”
• Carveouts: Gifts to Immediate Family
• Exclusions: minimal sales allowed (5-10%)

„ Rare: Cross-rights over other investors
31

Investor Protections And Rights
Drag-Along and Tag-Along
„ Drag-Along – Forced Sale Provision
• Offer to shareholders by outside party to purchase all shares
• If high % of shareholders accept, force remaining “holdouts” to sell
• % required to trigger (high – e.g., 75%)

„ Tag-Along (Co-Sale) [27]
• Founder wants to sell shares and has a buyer
• Investors have right to sell their shares (pro-rata) to Founder’s
buyer (instead of Founder)
• Exclusions: minimal sales allowed (5-10%)

„ Termination
• IPO, acquisition, sale of assets, dissolution
• Investor owns less than [5-15%] of purchased shares
• [3-5] years after close financing
• Majority Investors agree to terminate
32

Investor Protections And Rights
Information Rights and Covenants
„ Information Rights – Financials [15]
• What and When?
– Annual statements – [120 days]
– Quarterly financials – [45 days]
– Monthly statements – [45 days (possibly)]
– Budgets/Plan – [30 days after close fiscal year]

• Audited (costly, annual statements only)
• Who gets rights (minimum holdings/transfer) – 25%
• Termination - at IPO, acquisition, sale of assets

„ Market Standoff Restriction [20]
33

11

Investor Protections And Rights
Registration Rights [16, 17, 18, 19]
„ Demand Registration [16]
• Require Company to Register Investor Shares
• IPO or Subsequent Offering (S-1 “long form”)

„ S-3 Registration [18]
• “Short-form” Registration
• Available after 1 year (if required filings made)
• Much simpler, quicker, and cheaper

34

Investor Protections And Rights
Registration Rights [16, 17, 18, 19]
„ Issues for IPO Demand
• Demand IPO after how many years? (3-5)
• Minimum Offering for IPO? ($5-10M)

„ Issues for all Demands
• Number Demands allowed
– S-1: 1-2
– S-3: unlimited (but only 1-2 per year)
– Minimum Offering for S-3 demand ($1-3M)

• Minimum % Investor shares to require Demand
– 25-40% Investor Shares

• Can Company Delay Registration?
– 90-120 days / strategic or market reasons
35

Investor Protections And Rights
Registration Rights [16, 17, 18, 19]
„ Piggyback Registration [17]

• Require Company to Include Investor’s Shares in Company’s
Subsequent Offerings (not IPO)

„ Issues for Piggyback Registrations
• Underwriter Cutbacks (up to 20-25%)
• No piggyback on demand, S-3, benefit plans,
reorganizations

36

12

Investor Protections And Rights
Registration Rights [16, 17, 18, 19]
„ Issues for ALL Registrations
• Who Pays for Registration? [19]
– Company pays (except underwriting commissions)

– Including costs for counsel for selling shareholders

• Minimum holding by Investor to have rights
• Minimum amount for rights to transfer
• Termination of rights
– Some years after IPO (e.g., 7 years)
– To the extent shares that can be sold under
SEC Rule 144
37

Conclusion
ƒ Current financing environment strong and improving
ƒ Valuations continue to improve (along with VC investment, which increased
to $6.7B (Q2’06), vs. $6.2B (Q1’06) and $6.4B (Q2’05 – on track for largest
investing year since 2001)
ƒ Web 2.0 space very strong with large exits (YouTube, My Space)
ƒ IPO market still very weak for tech/web companies
ƒ To build interest
- Demonstrate customers/revenue product achievement
- Show company’s progress/milestones will be when the funding is spent
- Demonstrate large addressable market

ƒ Negotiate the important stuff, skip the small stuff
ƒ
ƒ
ƒ
ƒ

Valuation/Dilution, but don’t let it kill the deal
Liquidation Preferences
Protective Provisions
Board Control

ƒ Materials
ƒ Fenwick & West Financing Materials
ƒ Sample Venture Capital Term Sheet (annotated)
ƒ Q3 2006 Quarterly Venture Capital Terms Survey
38

Contact Information
Fenwick & West LLP

Samuel B. Angus, Partner,
Corporate and Venture Capital Group
Telephone: (415) 875-2440

email: sangus@fenwick.com

39

13

THIS TERM SHEET SUMMARIZES THE PRINCIPAL TERMS OF THE PROPOSED
FINANCING OF ______________________________ (THE "COMPANY"). OTHER THAN THE
PROVISIONS LABELED “CONFIDENTIALITY” AND “EXCLUSIVITY”, THIS TERM SHEET
IS FOR DISCUSSION PURPOSES ONLY. OTHER THAN THE PROVISIONS LABELED
“CONFIDENTIALITY” AND “EXCLUSIVITY”, THERE IS NO OBLIGATION ON THE PART
OF ANY NEGOTIATING PARTY UNTIL A DEFINITIVE STOCK PURCHASE AGREEMENT
IS SIGNED BY ALL PARTIES. THE TRANSACTIONS CONTEMPLATED BY THIS TERM
SHEET ARE SUBJECT TO THE SATISFACTORY COMPLETION OF DUE DILIGENCE.
THIS TERM SHEET DOES NOT CONSTITUTE EITHER AN OFFER TO SELL OR AN OFFER
TO PURCHASE SECURITIES.
[COMPANY NAME]
SERIES A PREFERRED STOCK FINANCING
SUMMARY OF TERMS
November __, 2006
[1]

Amount of
Financing:

Five Million Dollars ($5,000,000), including the conversion of
outstanding convertible notes in the amount of $500,000.

[2]

Type of
Security:

Eight Million Six Hundred Seventeen Thousand, Eight Hundred
Eighty-Six (8,617,886) shares of Series A Preferred Stock (the
"Purchased Shares", or the “Preferred Stock”), initially convertible
into an equal number of shares of Common Stock.

[3]

Purchase
Price:*

$0.5802 per share (the "Purchase Price"), based upon a Five Million
($5,000,000) pre-financing valuation of the Company, calculated on a
fully-diluted pre-financing capitalization of the Company (including a
15% post-financing stock option pool).

[4]

Closing:

On or around November __, 2006 (the "Closing").

Investors:

$2.25 million each from Tech Venture Partners, LLC, and Big
Returns Capital, L.P., and the holders of existing convertible notes.
PreFinancing
Shares
5,000,000

%

Post-Financing
Shares

%

58.02%

5,000,000

30.54%

Series A
Preferred Stock:

0

0%

8,617,886

52.63%

Convertible
Notes:
Common Stock
Warrants:
Current
Available Stock
Option Pool:

861,789

10.0%

0

0%

100,000

1.16%

100,000

0.61%

300,000

3.48%

300,000

1.83%

Current

200,000

2.32%

200,000

1.22%

Capitalization:
Common Stock:

1

Fenwick & West LLP ©
A9003/00000/SF/5132393.1

Outstanding
Stock Options:
New Future
Grants:
Totals:

2,156,098

25.02%

2,156,098

13.17%

8,617,886

100%

16,373,984

100%

* Please see the attached Sample Series A Preferred Stock Financing Analysis.
Conversion of Convertible
Notes:

The current outstanding Convertible Notes in the amount of Five Hundred
Thousand Dollars ($500,000) will automatically convert into 861,789
shares of Series A Preferred Stock at the Closing. This number of shares
is included in the total number of Purchased Shares to be issued, as set
forth above under "Type of Security."

Rights and Preferences of
Purchased Shares:
[5]

Dividend Rights:

The holders of the Purchased Shares shall be entitled to receive, out of
any funds legally available therefor, noncumulative dividends at a rate of
eight percent (8%) of the original Purchase Price per share of the
Purchased Shares, prior and in preference to any payment of any dividend
on the Common Stock in each calendar year. Such dividends shall be
paid when, as and if declared by the Board of Directors.
The dividend rights and preferences of the Purchased Shares shall be
senior to the Common Stock.
After the dividend preferences of the Purchased Shares has been paid in
full for a given calendar year, all remaining dividends in such calendar
year will be paid on the Preferred Stock and the Common Stock (on an as
converted basis).

[6]

Liquidation
Preference:

In the event of any liquidation, dissolution or winding up of the Company,
the holders of the Purchased Shares will be entitled to receive an amount
equal to the original Purchase Price per share of the Purchased Shares,
plus an amount equal to all declared but unpaid dividends thereon (the
"Preference Amount").
After the full liquidation preference on all
outstanding shares of Preferred Stock has been paid, any remaining funds
and assets of the Company legally available for distribution to
stockholders will be distributed pro rata solely among the holders of the
Common Stock.
The liquidation rights and preferences of the Purchased Shares shall be
senior to the Common Stock.
If the Company has insufficient assets to permit payment of the
Preference Amount in full to all holders of Purchased Shares, then the
assets of the Company will be distributed ratably to the holders of the
Purchased Shares in proportion to the Preference Amount each such
holder would otherwise be entitled to receive.

2

Fenwick & West LLP ©
A9003/00000/SF/5132393.1

A merger or consolidation of the Company in which its stockholders do
not retain a majority of the voting power in the surviving corporation, or a
sale of all or substantially all the Company's assets, will each be deemed
to be a liquidation, dissolution or winding up of the Company.
[7]

Redemption:

The Preferred Stock shall not be entitled to Redemption rights..

[8]

Voting Rights:

Each share of Preferred Stock carries a number of votes equal to the
number of shares of Common Stock then issuable upon its conversion into
Common Stock.
The Preferred Stock will generally vote together with the Common Stock
and not as a separate class, except as provided below.

[9]

Board of
Directors:

The Company's Certificate of Incorporation and
Board of Directors:
Bylaws shall provide for a Board of Directors consisting of five (5)
members. The number of directors cannot be changed except by
amendment of the Certificate of Incorporation by a vote of holders of at
least a two thirds (2/3) of the outstanding Preferred Stock.
With respect to the election of the Board, so long as at least 1,000,000
shares of Preferred Stock remain outstanding, then: (a) the holders of the
Preferred Stock will be entitled to elect two members of the Board; (b) the
holders of the Common Stock, voting together as a single class, will be
entitled to elect two members of the Board, one of whom shall be the
current CEO of the Company; and (c) the holders of the Preferred Stock
and Common Stock, voting together as a single class, will be entitled to
elect the remaining member of the Board, whom shall be an independent
director with industry experience.
The Company, the holders of the
Preferred Stock and the founders and other holders of Common Stock (the
"Stockholders") shall enter into a voting agreement setting forth such an
arrangement.
At the Closing, the Board of Directors shall consist of founder, founderCEO, representative of Tech Venture Partners, representative of Big
Returns Capital and industry expert.
So long as at least 1,000,000 shares of Preferred
Visitation Rights:
Stock remain outstanding, in the event that either Tech Venture Partners
or Big Returns Capital does not have a representative on the Board of
Directors, then such party (so long as it holds at least 20% of the Purchase
Shares issued to it in the financing) will be entitled to appoint one person
to attend the non-executive portion of Board of Directors meetings,
subject to the right of the Board of Directors to exclude such observer for
confidentiality or attorney-client privilege purposes.

[10]

Optional
Conversion:

The holders of the Purchased Shares shall have the right to convert the
Purchased Shares into shares of Common Stock at any time. The initial
conversion rate for the Purchased Shares shall be 1-for-1. All rights
incident to a share of Purchased Shares (including but not limited to rights
to any declared but unpaid dividends) will terminate automatically upon
any conversion of such share into Common Stock.

3

Fenwick & West LLP ©
A9003/00000/SF/5132393.1

[11]

Automatic
Conversion:

The Purchased Shares shall automatically be converted into Common
Stock, at the then applicable conversion rate, upon: (i) the closing of an
underwritten public offering of shares of Common Stock of the Company
at a public offering price of not less than three times the original Purchase
Price per share of the Purchased Shares for a total public offering price of
not less than (before payment of underwriters' discounts and
commissions) Ten Million Dollars ($10,000,000) (an "Approved IPO"),
or (ii) upon the written consent of holders of not less than two-thirds (2/3)
of the Preferred Stock then outstanding.

[12]

Antidilution
Protection:

Proportional antidilution protection upon stock splits (subdivision or
combination) or stock dividends or distributions on outstanding Common
Stock (the "Common Stock Event").
The conversion price of the Purchased Shares shall be subject to
adjustment to prevent dilution on a price-based broad-based weighted
average basis in the event that the Company issues additional shares of
Common Stock or Common Stock Equivalents at a purchase price less
than the then-effective conversion price; except, however, that without
triggering antidilution adjustments: (1) shares of Common Stock issued
or issuable upon conversion of the Preferred Stock; (2) up to 2,010,345
shares of Common Stock (and/or options, warrants or rights therefor) that
may be granted or issued to employees, officers, directors, contractors,
consultants or advisors of the Company (or any subsidiary) pursuant to
incentive agreements, stock purchase or stock option plans, stock bonuses
or awards, warrants, contracts or other arrangements, as approved by the
Board, (Such number of shares to be calculated net of any repurchases of
such shares by the Company and net of any such expired or terminated
options, warrants or rights and to be proportionally adjusted to reflect any
subsequent Common Stock Event; (3) any shares of Common Stock or
Preferred Stock (and/or options or warrants therefor) issuable or issued to
parties that are (i) actual or potential suppliers or customers, strategic
partners investing in connection with a commercial relationship with the
Company or (ii) providing the Company with equipment leases, real
property leases, loans, credit lines, guaranties of indebtedness, cash price
reductions or similar transactions, under arrangements, in each case
approved by the Board; or (4) shares of Common Stock or Preferred Stock
may be issued pursuant to the acquisition of another corporation or entity
pursuant to a consolidation, merger, purchase of all or substantially all the
assets of such entity, or other reorganization in which the Company
acquires, in a single transaction or series of related transactions, all or
substantially all of the assets of such entity or fifty percent (50%) or more
of the equity ownership in such entity, provided that such transaction or
series of transactions has been approved by the Company's Board of
Directors; (5) shares of Common Stock or Preferred Stock issuable upon
exercise of warrants outstanding as of the Closing; (6) shares of Common
Stock issued pursuant to a Common Stock Event; and (7) shares of
Common Stock issued or issuable in a public offering prior to or in
connection with which all outstanding shares of Preferred Stock will be
converted to Common Stock (all of the exceptions listed as (1) through (7)
above are hereinafter referred to as the "Antidilution Exceptions").

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[13]

Protective
Provisions:

So long as 500,000 shares of the Preferred Stock remain outstanding, the
consent of the holders of two-thirds (2/3) of the outstanding Preferred
Stock shall be required for: (i) any amendment or change to the Articles of
Incorporation or Bylaws that alters or changes the rights, preferences,
privileges or the restrictions provided for the Preferred Stock so as to
adversely affect such Preferred Stock; (ii) any reclassification of
outstanding shares or securities into shares having rights, preferences or
privileges senior to or on a parity with the preferences of the Preferred
Stock; (iii) authorization of shares of any class of stock having rights or
preferences superior to or on a parity with the Preferred Stock as to
dividend rights, liquidation, redemption or voting preferences; (iv) any
increase or decrease (other than by redemption or conversion) to the total
number of authorized shares of Preferred Stock; (v) any merger or
reorganization or consolidation of the Company with or into one or more
other corporations in which the stockholders of the Company immediately
prior to such event hold, immediately after, stock representing less than a
majority of the voting power of the outstanding stock of the surviving
corporation (other than for the purpose of changing the Company's
domicile) (an "Acquisition"); (vi) the sale of all or substantially all the
Company's assets; (vii) the liquidation or dissolution of the Company;
(viii) the declaration or payment of any dividend on the Common Stock
(other than a dividend payable solely in shares of Common Stock; or (ix)
amend the Bylaws to change the authorized number of members of the
Board of Directors.

Investors' Rights
Agreement:
[14]

Right of First
Refusal:

Each holder of Preferred Stock shall be given the right of first refusal to
purchase up to its pro rata share (based on its percentage of the Company's
outstanding common shares, calculated on a Common Stock equivalent
and an as-if-converted basis) of any equity securities offered by the
Company (other than any issuances which are Antidilution Exceptions (as
defined above)) on the same price and terms and conditions as the
Company offers such securities to other potential Investors. This right of
first refusal will terminate immediately prior to: (a) the Company's initial
underwritten public offering of its Common Stock if it qualifies as an
Approved IPO; or (b) an Acquisition or sale of all or substantially all the
assets of the Company.

[15]

Information
Rights:

So long as a holder of Purchased Shares continues to hold at least 20% of
shares of Preferred Stock (and/or Common Stock issued upon conversion
of such shares) acquired by such holder in the financing, the Company
shall deliver: (i) audited annual financial statements to the Investor within
120 days after the end of each fiscal year; (ii) unaudited quarterly
financial statements within 45 days of the end of each fiscal quarter; and
(iii) monthly unaudited financial statements within 45 days after the close
of each month and as soon as practicable, 30 days after the close of the
fiscal year, a copy of the Annual Operating Plan and the budget. These
information rights shall terminate upon (a) the Company's initial public
offering or (b) Acquisition or sale of all or substantially all the assets of
the Company.

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Registration
Rights:
[16]

Demand Rights:

If after three years following the closing, holders of at least forty percent
(40%) of the "Registrable Securities" (defined below) request that the
Company file a registration statement covering the public sale of
Registrable Securities with an aggregate public offering price of at least
Five Million Dollars ($5,000,000), then the Company will use its
reasonable, diligent efforts to cause such shares to be registered under the
Securities Act of 1933 (the "1933 Act"); provided, that the Company shall
have the right to delay such a demand registration under certain
circumstances for a period not in excess of one hundred twenty (120) days
each in any 12 month period.
"Registrable Securities" will include the Common Stock issuable on
conversion of the Purchased Shares and all shares of Common Stock held
by the two founders of the Company (the "Founders") for purposes of
"piggyback" registration rights only. Only Common Stock may be
registered pursuant to the registration rights to be granted hereunder.
The Company shall not be obligated to effect more than two registrations
under this demand right provision and shall not be obligated to effect a
registration during the six (6) month period commencing with the
effective date of the Company's initial public offering or any registration
under the 1933 Act in which Registrable Securities were registered.

[17]

Piggyback
Rights:

The holders of the Registrable Securities shall be entitled to "piggyback"
registration rights on all 1933 Act registrations of the Company
(excluding any demand registration, S–3 registration or registrations
relating to employee benefit plans and corporate reorganizations), subject,
however, to the right of the Company and its underwriters to reduce the
number of shares proposed to be registered pro rata in view of market
conditions. However, the underwriters' "cutback" right shall be restricted
so that (a) all shares held by Company employees or directors which are
not Registrable Securities shall be excluded from the registration before
any Registrable Securities are so excluded, and (b) the number of
Registrable Securities in such registration shall be no less than 20% of the
shares to be included in the Registration (except for a registration relating
to the Company's initial public offering or a registration pursuant to the
exercise of a demand registration, from which all Registrable Securities,
not holding demand rights may be excluded).

[18]

S-3 Rights:

Upon a written request received from holders of twenty percent (20%) of
the Registrable Securities, such holders of Registrable Securities shall be
entitled to registrations on Form S-3 (if available to the Company) unless:
(i) the aggregate public offering price of all securities of the Company to
be sold by stockholders in such registered offering is less than Two
Million Dollars ($2,000,000); (ii) the Company certifies that it is not in
the Company's best interests to file such Form S-3, in which event the
Company may defer the filing for up to One hundred twenty (120) days
once during any 12 month period; (iii) the Company has already effected
two registrations on Form S-3 during the preceding 12 months; or (iv) the
registration is in any jurisdiction in which the Company would be

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required to qualify to do business or execute a general consent to service
of process to effect such registration; or (v) the Form S-3 is not available
for such an offering.
[19]

[20]

[21]

Expenses:

The Company shall bear the registration expenses (up to a maximum of
$30,000 and exclusive of underwriting discounts and commissions but
including the fees of one counsel for the selling stockholders, who may be
Company counsel) of all such demand and piggyback registrations, and
for the first S-3 registration.

Transfer of
Rights:

The registration rights may be transferred to transferees acquiring at least
100,000 shares of Registrable Securities. Assignments may be made
without the Company's consent and without regard to the minimum
number of shares of Registrable Securities noted above if the assignment
is to a partner, stockholder, parent, child or spouse of the holder, or a trust
for the benefit of such individuals or to the holder's estate.

Market Standoff
Provisions:

No holder will sell shares within such period requested by the Company's
underwriters (not to exceed one hundred eighty (180) days after the
effective date of the Company's initial public offering); provided,
however, that such agreement is not applicable to Registrable Securities
included in such registration statement; and provided further, that all
executive officers, directors and employee-stockholders of the Company
holding more than one percent (1%) of the outstanding shares enter into
similar standoff agreements with respect to securities of the Company
they hold that are not included in such registration. Holders agree to enter
into any agreement reasonably required by the Underwriters to implement
the foregoing.

Other Provisions:

Registration rights provisions may be amended with the consent of the
holders of more than two-thirds (2/3rds)of the Registrable Securities then
outstanding. The Company agrees to keep the registration statement
effective for up to ninety (90) days. Other provisions shall be included
with respect to registration rights as are reasonable, including crossindemnification.

Termination:

These registration rights will terminate five (5) years after the closing of
the Company's initial public offering and will not apply to any shares that
can be sold in a three (3) month period without registration pursuant to
Rule 144 promulgated under the 1933 Act.

Stock Purchase
Agreement:

The purchase of the Purchased Shares shall be made pursuant to a Stock
Purchase Agreement drafted by Company counsel reasonably acceptable
to the Company and the Investors, which agreement shall contain, among
other things, customary representations and warranties of the Company,
covenants of the Company reflecting the provisions set forth herein, and
appropriate conditions of Closing. The Stock Purchase Agreement shall
provide that it may be amended by, or that any waivers thereunder shall
only be made with the approval of, the holders of more than a majority of
the Purchased Shares (and/or Common Stock issued upon conversion
thereof).

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[22]

Restrictions on
Sales:

The Investors will make customary investment representations, including
verification of status as an "accredited Investor" within the meaning of
Regulation D under the 1933 Act. The Investors agree to provide the
Company with completed Investor Suitability Questionnaire to verify
such status.

[23]

Conditions to
Closing:

Each officer and employee of the Company shall have entered into
acceptable confidentiality and invention assignment agreements.
The completion of the investors due diligence of the Company.
An opinion of counsel for the Company.

[24]

Covenant
regarding
Vesting:

[25]

Covenant
regarding
Founder Vesting:

Stock sold and options granted to employees will normally be subject to
vesting as follows, unless otherwise approved by the Board of Directors:
(a) vesting over four (4) years – twenty-five percent (25%) of the shares
vest at the end of the first year, with 1/36th of the remaining shares vesting
monthly thereafter over the next three years, and (b) a repurchase option
shall provide that upon termination of the employment of the stockholder,
with or without cause, the Company retains the option to repurchase at
cost any unvested shares held by such stockholder.
Stock sold and options granted to Founders will be subject to vesting as
follows: (a) twenty-five percent (25%) of the shares shall be fully vested
at the closing, and (b) the balance of the shares vesting monthly thereafter
over the next three years, and (b) a repurchase option shall provide that
upon termination of the employment of the stockholder, with or without
cause, the Company retains the option to repurchase at cost any unvested
shares held by such stockholder; provided that in the event that the
Founders employment with the Company is terminated without cause or
by the Founder for good reason in connection with or within twelve (12)
months of an Acquisition of the Company or a sale of all or substantially
all the Company's assets, then all shares then unvested shall fully vest.
“Cause” and “good reason” will be defined in the definitive financing
agreements.
The Company and the Investors shall each indemnify the other for any
finder's fees for which either may be responsible.

Legal Fees &
Expenses:
[26]

At the Closing, the Company shall pay the reasonable fees and expenses
of Investors' counsel up to a maximum of Thirty Thousand Dollars
($30,000).

Right of First
Refusal and CoSale Agreement:
Right of First
Refusal:

Only after the Company has exercised its right of first refusal, the holders
of Preferred Stock (the "Refusal Holders"), shall have, on a pro rata basis,
calculated based on the Refusal Holders' holdings of Preferred Stock only,
a right of first refusal on the sale of current shares of Common Stock held
by the Founders (the "Transferor"), as of the date of the transfer (the

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"Stock") which are not purchased by the Company pursuant to its rights of
first refusal. The Investor’s right of first refusal shall not apply to five
percent (5%) of the Stock or 250,000 shares of Stock held by each
Transferor (the "Excluded Stock") and the term "Transfer" or
"Transferred" shall not include: (i) any pledge of Stock pursuant to a
bona fide loan transaction which creates a mere security interest, (ii) any
gift during Transferors' lifetime or upon death or intestacy to "Immediate
Family" provided such transferee agrees to be bound by the terms of the
Rights of First Refusal and Co-Sale Agreement. Immediate Family shall
mean the Transferor’s spouse, lineal descendants or antecedents (natural
or adopted), brothers, sisters or spouse of any of the foregoing, (iii) any
transfer pursuant to a merger, consolidation or winding up and dissolution
of the Company or an initial public offering of the Company's shares, (iv)
any transfer to an Investor pursuant to the Co-Sale Rights or Right of First
Refusal and (v) any transfer of Stock upon Company's exercise of its right
of first refusal or right of repurchase pursuant to an agreement between
the Transferor and the Company, entered into at the time of purchase of
the Stock (the "Permitted Exemptions").
[28]

Right of Co-Sale:

The holders Preferred Stock (the "Co-Sale Holders"), shall have, on a pro
rata basis, calculated based on a numerator which is the number of
Preferred Shares owned by such Investor and the denominator which
includes the Co-Sale Holders' holdings of Preferred Shares and the
Transferor's holdings of Stock calculated on as-converted to common
stock equivalent basis, a Right of Co-sale on the Stock which is not
otherwise sold to the Company or an Investor. This Right of Co-Sale
shall not apply: (1) to any Excluded Stock, plus any transfers which are
Permitted Exemptions.

Termination:

This Right of First Refusal and Co–Sale Right of the holders of Preferred
Stock will terminate upon the earlier of (i) agreement by the Company
and holders of a majority of the voting power of the Preferred Stock, or
(ii) immediately prior to the close of the sale of the Company's stock in an
initial public offering, or (iii) dissolution of the Company, or (iv) an
Acquisition, or a sale of all or substantially all the Company's assets, or
(v) the date the Investors own less than twenty percent (20%) of the
Preferred Stock; or (vi) eight (8) years after the effective date of the
Closing.

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Counsel to the
Company:

Fenwick & West LLP

Confidentiality:

No announcement regarding the Investors or the financing may be made
without the prior consent of Tech Venture Partners and Big Returns
Capital; provided that foregoing is not intended to prohibit (a) the
Company from disclosing any of the financing terms (including
information regarding investors or the financing) to its current or bona
fide prospective investors, employees, investment bankers, lenders,
accountants, and attorneys; or (b) disclosures deemed legally advisable
under applicable governmental orders, laws, rules or regulations. This
paragraph is intended to be legally binding.

Exclusivity:

By accepting this Summary of Terms, and in consideration for the efforts
of Tech Venture Partners and Big Returns Capital in evaluating and
pursuing the transactions contemplated hereby, the Company agrees (i)
not to discuss, negotiate or otherwise interact with any other persons or
entities relating to the financing, recapitalization or sale of assets or
business of the Company until November __, 2006, and (ii) to keep the
existence and terms of this Summary of Terms confidential (except for
disclosure to the Company’s professional advisers and current
stockholders and lender on an as-needed basis). This paragraph is
intended to be legally binding.

This Summary of Terms will expire if not accepted by 5pm PST November __, 2006.
Accepted by:
Tech Ventures Partners, LLC

Big Returns Capital, L.P.

By: __________________

By:

Name:________________

Name:

Title: _________________

Title:

Date:_________________

Date:

Accepted by:
[Company], Inc.
By: _________________
Name:________________
Title: _________________
Date:________________

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Other than the provisions labeled “Confidentiality” and “Exclusivity”, this Summary of Terms and the
proposed terms set forth above do not constitute a binding agreement or commitment of the Investors, the
Company or any of their affiliates. Any such agreement or commitment will only be contained in
definitive agreements (containing the usual representations, warranties, conditions and covenants for this
type of transaction) to be negotiated, executed and delivered, if at all, after the completion of appropriate
due diligence and approval of the Company’s Board of Directors. Either party to the negotiations may
terminate negotiations at any time for any reason and each party will bear its own expenses if a definitive
agreement is not signed.

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Sample Series A Preferred Stock Financing Analysis
Series A Financing Calculation
Pre-Financing Shares
Capital Stock
Series A Stock
Common Stock

0
5,000,000

Convertible Securities
Convertible Notes (included in pre-financing)(1)
Common Stock Warrant(2)

% of Cap

Post-Financing Shares

58.02%

8,617,886
5,000,000

52.63%
30.54%

861,789
100,000

10.00%
1.16%

0
100,000

0.61%

Existing Option Shares (currently available)
Existing Option Shares (currently outstanding)

300,000
200,000

3.48%
2.32%

300,000
200,000

1.83%
1.22%

New Reserved Option Shares (included pre-financing)

2,156,098

25.02%

2,156,098

13.17%

Total Option Shares (available and outstanding)

2,656,098

30.82%

2,656,098

16.22%

Totals

8,617,886

100%

16,373,984

100.00%

No. of Shares of Series A Stock
Price of Series A Stock $

-

% of Cap

8,617,886
0.5802

Pre-Financing Valuation $

5,000,000

Investment Total $

5,000,000

Notes
Note (1): Includes shares issuable upon conversion of convertible notes with an aggregate principal amount outstanding of $500,000.
Note (2): Reflects warrants to purchase Common Stock to be issued upon conversion of the convertible notes at the closing of the Financing.
Note (3): Reflects additional shares to be reserved under the Company's Equity Incentive Plan in connection with the Financing.

Venture Capital for High Technology Companies

About the Firm
Fenwick & West LLP provides comprehensive legal services to high technology and biotechnology
clients of national and international prominence. We have over 250 attorneys and a network of
correspondent firms in major cities throughout the world. We have offices
in Mountain View and San Francisco, California.
Fenwick & West LLP is committed to providing excellent, cost-effective and practical legal services
and solutions that focus on global high technology industries and issues. We
believe that technology will continue to drive our national and global economies, and look
forward to partnering with our clients to create the products and services that will help build great
companies. We differentiate ourselves by having greater depth in our understanding
of our clients’ technologies, industry environment and business needs than is typically expected
of lawyers.
Fenwick & West is a full service law firm with “best of breed” practice groups covering:
n

Corporate (emerging growth, financings, securities, mergers & acquisitions)

n

Intellectual Property (patent, copyright, licensing, trademark)

n

Litigation (commercial, IP litigation and alternative dispute-resolution)

n

Tax (domestic, international tax planning and litigation)

Corporate Group
For 30 years, Fenwick & West’s corporate practice has represented entrepreneurs, high technology
companies and the venture capital and investment banking firms that finance them. We have
represented hundreds of growth-oriented high technology companies from inception and
throughout a full range of complex corporate transactions and exit strategies. Our business,
technical and related expertise spans numerous technology sectors, including software, Internet,
networking, hardware, semiconductor, communications, nanotechnology and biotechnology.

Our Offices
801 California Street

555 California Street, 12th floor

950 W. Bannock Street, Suite 850

Mountain View, CA 94041

San Francisco, CA 94104

Boise, ID 83702

Tel: 650.988.8500

Tel: 415.875.2300

Tel: 208.331.0700

Fax: 650.938.5200

Fax: 415.281.1350

Fax: 208.331.7723

For more information about Fenwick & West LLP, please visit our Web site at: www.fenwick.com.
The contents of this publication are not intended, and cannot be considered, as legal advice or opinion.

Venture Capital for High Technology Companies
Introduction....................................................................................................................... 1
Typical Start-Up Questions.................................................................................................2
Threshold Issues When Starting Your Business...................................................................3
Recruiting Your Team..........................................................................................................4
Seed Financing................................................................................................................. 10
Financing — the First Round...............................................................................................11
The Structure of a Typical Venture Financing..................................................................... 13
Employee Stock Plans....................................................................................................... 16
Corporate Partnering........................................................................................................ 16
When Should you Consider an Acquisition?....................................................................... 17
Financing — the Second Round......................................................................................... 17
The Initial Public Offering................................................................................................. 18
Conclusion........................................................................................................................ 19
Appendix A: Illustrative Financing Scenarios.....................................................................20
Appendix B: Series B Preferred Stock Term Sheet..............................................................22
About the Author.............................................................................................................. 27

Introduction
Founding your own high-growth, high technology company, financing it with venture capital
and successfully bringing a product to market is a challenging experience. Entrepreneurs are
dynamic people, motivated by their vision of a unique product concept and the drive to make
that product a successful reality. Because founding a successful high tech company is so
different from working in a large company, many new entrepreneurs are unfamiliar with the
legal issues involved in creating a high tech start-up.
This booklet introduces new entrepreneurs to a variety of legal and strategic issues relating
to founding and financing a start-up company, including determining your product and
market, assembling the right founding team, choosing your legal structure, making initial
stock issuances to founders, obtaining seed financing, negotiating the terms of your venture
financing and the pros and cons of being acquired or taking your company public.
At the end of the booklet, we provide two Appendices. The first Appendix offers a set of
financing scenarios that illustrate typical amounts of venture capital raised, company
valuations at different stages of a company’s existence and how ownership changes over
time — first with a company that is successful and second with a company that undergoes a
“down round” of financing. The second Appendix is a sample Series B Preferred Stock Term
Sheet, illustrating the type of provisions you might see requested by a venture capitalist.
Of course, no two companies are identical and, accordingly, not all issues encountered are
discussed, nor will every start-up face all of the issues discussed below. However, they are
typical of the start-up companies Fenwick represents.
The following are other available Fenwick booklets: 

venture capital

n

Acquiring and Protecting Technology: The Intellectual Property Audit

n

Annual Update: International Legal Protection for Software

n

Copyright Protection for High Technology Companies

n

Corporate Partnering for High Technology Companies

n

International Distribution for High Technology Companies

n

Mergers and Acquisitions for High Technology Companies

n

Patent Protection for High Technology Companies

n

Patent Licensing for High Technology Companies

n

Structuring Effective Earnouts

n

Trademark Selection and Protection for High Technology Companies

n

Trade Secrecy: A Practical Guide for High Technology Companies

fenwick & west

Typical Start-Up Questions
What is “vesting”?  “Vesting” requires founders to earn their stock over time. The company
retains aright to buy back unvested stock at the original purchase price on termination of
employment. In contrast to founders stock, stock options typically become exercisable as
they vest.
Why do I want vesting?  Vesting protects founders who remain with the company from an
ex-founder becoming wealthy on their efforts if that ex-founder quits before he or she has
earned his or her stock. Venture capitalists require vesting as a condition to funding your
company.
How do I avoid tax liability on the receipt or vesting of founders’ stock?  Incorporate early
and issue founders’ stock at a low price to the founding team before you bring in outside
investors. File your 83(b) election with the IRS within 30 days of purchase.
How are venture financings structured?  Companies sell convertible preferred stock to
outside investors. Employees continue to buy common stock at a fraction of the price paid
by the outside investors. The price differential starts at 10 to 1 and then declines as the
company nears an IPO or acquisition.
What do I have to give away in negotiations with venture capitalists?  Typical deals include
basic preferred stock liquidation and dividend preferences, weighted average antidilution
protection and registration rights. You’ll also have to agree to certain restrictions on how you
run your company. Actual terms will vary depending on the quality of your company and the
current financing environment.
What should I try to avoid in negotiations with venture capitalists?  Avoid ratchet
antidilution protection, mandatory redemption, redemption premiums, super liquidation
preferences and excessive restrictions on how you run your company.
How do I protect my technology?  Use nondisclosure and assignment of invention
agreements and consider patent, trademark, trade secret and copyright protection at an
early stage.
How do I choose a lawyer?  Choose one with substantial start-up experience working with
your type of business. It is also helpful if the lawyer’s firm has the intellectual property,
corporate and securities laws, domestic and international tax and litigation expertise that
your company will need as it grows.

fenwick & west

venture capital 

Threshold Issues When Starting Your Business
Identifying a Market Need
The first step in starting your new business venture is to identify a market need and the
product or service that will meet that need. Too often, high tech products and businesses
are launched because the founders become fascinated by their new technology without first
determining whether the technological advance will cost-effectively meet customers’ needs.
Your products and services should be defined and shaped in response to real problems
being experienced by real customers. In tough markets, you may have to show customer
acceptance of your product or revenue in order to raise venture capital or angel funding.
Product Definition
You must determine the competitive edge that will make your proposed product preferable
to comparable products currently used in the target market. Will your product accomplish
the job faster, or be easier to use, more reliable and cheaper to produce or service? Will
these advantages be long- or short-term? Critically evaluate your plan to ensure that your
technological advances will provide cost-effective and reliable solutions to the customer’s
problem or fill new market requirements and will allow your company to become profitable.
Market Evaluation
Once you have defined your product in terms of a market need, you should evaluate that
market. What types of customers will need the benefits your product offers over competing
products? Is it a product that will be used by individuals, by small businesses, by Fortune
500 companies, by the government or by foreign customers? The customer base frequently
dictates the distribution channels best used to reach your customers. A direct sales force may
be required to reach the Fortune 500 market, while a low-priced consumer product generally
will be sold through retail distribution or for end-use software via Internet downloads. How
large is the market today and how large will it be in five years? A large and growing potential
market is essential to obtaining venture capital. Most venture capitalists look for companies
that can become profitable and attain at least $100 million a year in revenues in the next
10 years (possibly longer for bioscience companies). Knowing your customer base is a
prerequisite to knowing what skills, experience base and connections you will need from
your founding team and advisors.
Capital Needs
Once you have assessed your product and its market, you should determine the capital
needed to fund its development and commercial exploitation. To avoid excessive dilution,
the best approach is to stage the capital raised by development milestones, making sure
that you raise enough money at each stage to attain your milestone with some cushion.
Milestones met reduce investment risk and increase the company’s valuation. Milestones
missed increase investment risk and reduce the company’s valuation. You also need to
evaluate how quickly you want to grow the company and what capital would be needed for 
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slow and fast growth scenarios. Finally, consider currently available sources of capital and
their expected financing terms and rates of return on their investment. Your company’s
capital needs will be a fundamental issue for investors, and should be presented clearly in
the company’s business plan.

Recruiting Your Team
Composition of the Team
After you have defined the product, its market and the skills needed to bring the product to
market, the next step is to put together a founding team. The people you select to make up
the founding team are vital to the success of the company. While you may not be comfortable
with sharing control of ideas and profits with others, your success will depend on recognizing
your strengths and weaknesses early on and recruiting people with skills to complement
your own. Ideally, a well-rounded founding team should include the following key managers:
n

Chief Executive Officer

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Vice President of Research and Development

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Vice President(s) of Sales and/or Marketing

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Chief Financial Officer/VP Administration

Quality Leadership
You may not be able to recruit all the members of your founding team at once. Take time to
recruit the best possible people who are experienced at doing the things your business will
need to succeed. Be realistic about your own skills. If you have not had direct experience
in managing and growing an organization, recruit a strong CEO who knows how to build a
company and translates ideas into successful products. Your ability to obtain funding and
the ultimate success of your business depends on the excellence of the people you recruit for
your founding team.
Inexperienced key managers in a start-up are more likely to fail and need to be replaced as
the company grows. Hiring key replacements is disruptive to your organization and will result
in additional dilution of the ownership interests of the original founders. The percentage
of the company that the founders will be able to retain is a direct function of their ability to
handle key management roles well throughout the company’s growth. The financing scenario
at the end of this booklet, which shows the founders retaining 22 percent of the company’s
stock at the initial public offering, assumes a strong founding team in a company needing
relatively little outside capital. A weaker team or one that requires larger capital infusions
could retain less than 3-5 percent of the company’s equity by the initial public offering.
Board of Directors
In addition to recruiting your founding team, you will need to recruit people to serve on
your company’s board of directors. The board of directors is the governing body of the
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corporation, owing fiduciary duties to all shareholders. It elects the company’s officers and
approves all major decisions. The board takes action by majority vote.
As a result, a founder-CEO-director, who owns a majority of the shares, can still be outvoted
on the board on such important matters as sales of additional stock and the election of
officers. Thus, careful selection of an initial board is essential. You want board members
whose judgment you trust (even if they disagree with you) and who can provide you with
input and resources not available from your management team. You might also consider
recruiting industry experts to serve on an advisory board to assist you with technology and
marketing issues.
Legal Structure
The next step is selecting the legal structure for your company. You have a choice among the
following structures:
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Proprietorship

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Partnership or LLC

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Corporation

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S Corporation

Although most high tech companies are corporations, it is sometimes preferable to organize
your business as a proprietorship or partnership. Before choosing your legal structure,
consult with legal and accounting advisors. The following summary can help you select the
right structure for your business.
Proprietorship
A proprietorship is simple. You own your own business. You and your business are
considered one and the same — there is no legal distinction. All income received by the
business is taxable to the individual proprietor, and the proprietor has unlimited liability
for all obligations and debts of the business. Although this structure is not recommended
for high-growth companies, it may be beneficial for inventors who wish to license their
technology for royalties. Typically, an inventor will pay far less income tax as a proprietorship
than as a corporation.
Partnership
In a partnership, two or more people operate a business together and divide the profits.
General Partnership: In a general partnership, any partner can bind all other partners for
actions within the scope of the partnership’s business. All partners have equal management
rights and unlimited liability for partnership obligations.
Limited Partnership: In a limited partnership, there are two types of partners, passive and
active. The passive or limited partners have no say in day-to-day management. Their liability, 
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like that of shareholders in a corporation, is limited to their investment in the partnership.
The active or general partners act as they would in a general partnership.
In both types of partnerships, profits and losses can be allocated among the partners in
varying ways and are taxable to the partners when recognized by the partnership. The ability
to allocate initial losses to limited partners, within IRS limits, makes partnerships attractive
for financing tax-advantaged research and development transactions. While investors in
a corporation generally cannot deduct money invested until the stock is sold or becomes
worthless, partners can currently deduct their share of a partnership’s losses. Limited
liability companies (LLCs) are similar to limited partnerships, but are typically inappropriate
for fast growth companies since, unlike corporations, they do not easily accommodate
employee option plans and a corporation cannot do a tax-deferred acquisition of an LLC.
Corporation
The most common structure used by high tech companies is the corporation.
A corporation is a legal entity that is separate from the people who own and operate it. The
shareholders own the corporation and elect a Board of Directors. The Board of Directors
governs the corporation and appoints the officers who manage its day-to-day business.
A corporation pays income tax on its income, while its shareholders generally pay income tax
only on dividends received. Shareholder liability for corporate obligations is generally limited
to their investment in their shares.
One advantage of a corporation is that it can have different classes of stock with different
rights. In addition to common stock, it can create and sell preferred stock, having
preferences over the common stock. The preferences justify selling common stock to
employees who provide “sweat equity” in the business at a substantial discount from the
price paid by outside investors for the preferred stock. If your company will need substantial
capital, intends to grow rapidly and/or will have substantial numbers of employees requiring
equity incentives, you should probably incorporate.
S Corporation
If you won’t seek venture capital immediately, but want a corporate structure, you should
consider electing to be treated as an S corporation. An S corporation is treated much
like a partnership for tax purposes. Corporate income and losses will pass through to
the shareholders, enabling the founders to offset their other personal income with the
corporation’s initial losses.
There are strict rules regarding S corporations. An S corporation can have only one class of
outstanding shares and no more than 75 shareholders. Shareholders must be U.S. resident
individuals or trusts (not partnerships or corporations). These rules make it impractical for
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most high-growth start-ups to remain S corporations. For example, upon the sale of common
stock to a corporate investor or a venture capital partnership or the sale of preferred stock to
any investor, S corporation status will automatically be lost. You can, however, start as an S
corporation and later elect to be treated as a C (or normal) corporation.
Initial Stock Issuances to the Founders
If you select the corporation as your form of business entity, the next step is to incorporate
the company and issue stock to the founders. You will need to consider stock valuation,
income tax considerations, vesting and buy-back rights, the availability of seed financing and
compliance with securities laws.
How do You Value Founders’ Stock?
It is often difficult to estimate the value of a start-up since it has no business or earnings
history. Typically, there is no readily ascertainable value for the stock issued, so founders’
stock is usually issued at a nominal price, such as $0.001 per share, paid in cash. However,
if you or other founders contribute property or rights to previously existing technology or
inventions, you must value the property contributed in exchange for the stock.
It is important to make founders’ stock issuances as early as possible to avoid potential
adverse income tax consequences. If stock is issued to employees at a low price at the same
time that it is issued to outside investors at a higher price, the IRS will treat the difference
between the two prices as taxable compensation to the employee.
How do Founders Avoid Income Tax Liability?
There are several ways to avoid income tax on founders’ shares when selling equity to other
investors.
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Issue the founders’ stock early and allow time to pass before issuing stock to outside
investors at a higher price.

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Create value in your company between the issuance of founders’ stock and issuances
to investors. You can create such value by writing a business plan, creating a product
prototype or signing a letter of intent with a prospective customer.

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Create a two-tiered capital structure of common and preferred stock. Preferred stock
preferences justify charging outside investors a higher price than employees who
purchase common stock.

Vesting Schedules and Buy-Back Rights
Because founders buy their initial equity at a nominal price, they should “earn” their stock
over a “vesting” period based on their continued service to the company. A typical vesting
arrangement would provide that shares vest over four years, with no shares vesting in
the first year of employment, 25 percent of the shares vesting at the end of that year, with
two percent of the shares vesting monthly thereafter. Since there is a risk of job loss in an 

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acquisition, some vesting arrangements accelerate the founders’ vesting by 12 months or
more if the company is acquired.
Your company should retain the right to repurchase an employee’s unvested shares at the
original purchase price on termination of employment. A minority of companies also retain
the right to repurchase vested shares on termination of employment at the then-current fair
market value of the company’s stock although that has adverse accounting implications. In
addition, most private companies retain a right of first refusal on shareholder resales of their
stock, primarily to keep stock from falling into unfriendly hands.
Why Have Vesting and Buy-Back Rights?
Vesting is important, even though many founders dislike it. Best intentions notwithstanding,
all the original members of a founding team may not remain with the company. Some conflict
may arise causing one or more team members to leave the venture. If this happens in a
company without vesting, enormous resentment results towards the ex-founders who keep
their stock and “free-ride” on the efforts of those who continue to build the company.
With vesting and buy-back provisions, an ex-founder is allowed to keep only those shares
that vested during his or her tenure. This is more fair and reflects the ex-founder’s actual
contribution to the company’s success.
On a more pragmatic note, if you and the other founders do not impose vesting, the venture
capitalists will. Since venture capitalists generally bring the first substantial capital to most
start-ups, they will insist that the founders earn the value contributed by the financing over a
standard-vesting period before they invest.
What is an 83(b) Election?
Whenever your company reserves the right to buy back stock at the original purchase price
on termination of your employment, you should consider filing a Section 83(b) election with
the IRS. By filing this election, you, as the purchaser, are electing to be taxed immediately on
the difference between the fair market value of the stock and the price you paid for it. If you
paid fair market value for the stock, then you will not pay any taxes as a result of the election.
If you do not file a Section 83(b) election within 30 days of your stock purchase, you will be
taxed on each vesting date on the difference between the fair market value of the shares
vesting on that date and the price paid for them. That difference could be substantial if the
company’s stock value substantially appreciates, and the tax may be payable before the
shares can be sold.
How do you Protect Your Company’s Technology?
Next to your people, your company’s inventions and technology may be its most precious
assets. A few simple steps are necessary to protect that technology. If the founders have
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developed technology prior to incorporating the company, have them assign the intellectual
property rights to the company. From the very beginning, all company employees should sign
the company’s standard form of confidentiality and assignment of inventions agreement.
Have third parties sign a nondisclosure agreement before giving them access to your
confidential technology. Consult competent intellectual property counsel to find out if your
technology qualifies for copyright or patent protection. Rights can be lost if notice and
filing requirements are not met in a timely fashion. Consult trademark counsel before you
select your company, product and domain names to find out if they infringe someone else’s
trademarks and to take the steps necessary to obtain exclusive rights to those names. (See
the Fenwick booklets on Copyright, Trade Secrecy, Trademark and Patent Protection for a
detailed discussion of these issues.)
Preparing a Business Plan
A business plan is an excellent tool for planning your business and assessing your
performance. It also can help sell your company to potential investors. The time invested in
developing a good business plan will have major long-term returns.
The business plan should be no more than 25 to 30 pages long. It should be prefaced by a
two-page “executive summary” highlighting the following topics that should be set forth in
greater detail in the actual business plan:
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Company description, location, and history;

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Product(s) to be developed and underlying technology;

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Size and growth rate of the market;

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Competition;

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Company’s competitive advantage;

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Management team;

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Financial summary of projected revenues and income, balance sheets and cash flow
statements for five years, with monthly detail for the first two years and

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Amount and structure of the proposed financing.

The bulk of the business plan should focus on the issues the venture capitalists are most
interested in: the size and growth rate of the market, your targeted customers, competitors
and your competitive advantage and the background of the management team. The business
plan should not be a technical treatise on product development or market analysis. You
should address these issues, of course, but it is preferable to compile an appendix to the
business plan containing that information to be provided to investors who show serious
interest. If you have never written a business plan, consult some of the detailed materials
provided by many major accounting firms. Before presenting it to the venture capitalists,
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Seed Financing
What is Seed Financing?
Some founding teams with strong track records can raise venture capital without a business
plan or a product prototype. Most people, however, find it necessary to seek a small amount
of “seed” money from friends, relatives, angels or “seed round” venture capitalists. This
seed money is used to support the fledgling company while a business plan is written or a
product prototype is developed.
Where can you Find Seed Money?
Obtaining capital from outside investors during the early stages of your company’s
development may be difficult. Since only small amounts of money are usually required at
this early stage, friends and family may be a realistic source of seed money. Accept money
only from those who are sophisticated enough to understand the risk and who can afford
to lose their investment. Doing so helps you comply with securities laws and maintain good
relations if your company does not succeed.
Few start-ups can obtain seed money from the venture capital community. For an as yet
unproven start-up, it can take six to eighteen months to build venture capital contacts,
educate them about your product idea and convince them of the strength of your founding
team.
Given these difficulties, it may be better for your start-up to try to attract “angels” or
“advisory investors,” such as a successful entrepreneur with self-generated wealth in a
related industry. This type of investor will understand the merits and weaknesses of your
business idea. More important still, these investors can be invaluable in helping you pull
together the company and in introducing you to the venture community.
Compliance with Securities Laws
Although your company’s initial resources will probably be limited, you must comply with
federal and state securities laws when issuing stock or granting employee stock options. At a
minimum, noncompliance gives purchasers a rescission right that can compel your company
to refund the entire purchase price of the stock. You and your company might also be subject
to fines and criminal liability. Meeting the legal requirements is not necessarily expensive if
you have competent legal counsel to advise you before you offer to sell the stock. Exemptions
from the costly process of registration with the Securities and Exchange Commission (SEC)
will usually be available if you are careful in selecting the investors to whom you offer the
securities and in making the offer. Filings with federal and state securities agencies may also
be required.

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What do the Venture Capitalists Want?
Most venture capitalists are looking for a company that can be profitable and grow to at
least $100 million or more in revenues in 10 years (possibly more for bioscience companies).
They are looking for large and growing markets where there is a demonstrable need for the
product the company plans to develop. Many venture capitalists say that they would rather
take a technology risk (can the product be developed?) than a market risk (will people want
the product?). Technology risks are generally eliminated earlier when the capital needed
and the company’s valuation are less, while market risks will not be eliminated until after
the product has been completed and introduced into the market. Venture capitalists also
tend to “invest in people” rather than in ideas or technologies. Hence the strength of the
management team is the most crucial element in raising money.

Financing — the First Round
How Should you Select a Venture Capitalist?
Selecting the right venture capitalist is as important as picking the right founding team. Take
the time to talk to the venture capitalist to ensure that you can work well together. Look for
someone who knows your industry. An ideal candidate would be someone who knows your
product or market and is located close enough to your company to be available when you
need help. It is also important as you launch your business to get people who have the depth
and breadth of experience that you may initially lack.
If chosen correctly, venture capitalists can provide a wealth of information on management
techniques, problem solving and industry contacts. They also can offer a broader perspective
on your product’s market fit, as well as additional funding as your company grows.
If, on the other hand, a venture capitalist is incorrectly chosen, you may find that the capital
invested is tied to needless operating restrictions and monthly headaches at board meetings
where you will regularly be asked why you are not “on plan.” Where funding is available from
several venture firms, ask the CEOs of their portfolio companies about their experience with
the respective venture capitalists.
How do you Find Venture Capitalists?
There are many sources of basic information about venture capital firms. Some of the
published sources include Pratt’s Guide to Venture Capital Sources and the Directory of the
Western Association of Venture Capitalists. Venture One has the best database on venture
capitalists and the companies they fund. Through it you can find out which venture capital
firms invested in similar companies and which partners of those firms sit on their Boards
of Directors. While this database is not available to the public, most major law firms with a
startup focus have licenses to it.

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The best way for you to meet venture capital investors is to be introduced to them through
successful entrepreneurs who have been funded by them. Other good sources include
lawyers, accountants and bankers who focus in working with high tech companies. If at all
possible, make sure that you are introduced or have your business plan forwarded to the
venture capitalist by one of these people. While your business plan has to stand on its own
merits, an introduction from a credible source can ensure it more than a cursory review and
can result in useful feedback if the venture capitalist decides not to invest.
How Much Money Should you Raise?
In the first round of venture capital financing, you should try to raise a sufficient amount
of capital to fund product development. The business plan usually will set a demonstrable
risk-reducing milestone, such as having a working product ready for production. Given the
seemingly inevitable delays in product development and the time it takes to arrange the
next round of financing (at least two to six months), you should build some cushion into the
amount you raise.
How Much is Your Company Worth?
Determining the value of your company at this early stage is more of a “mystic art” than a
calculated formula. In theory, investors attempt to estimate the value of the company at
some time in the future (say 10 to 20 times earnings in year five). They then discount that
value to a present value with a desired rate of return. If the investor is looking for a tenfold
return in five years and the company is expected to be worth $50 million in five years, it may
be worth $5 million today.
In practice, however, venture capitalists seem to estimate the amount of cash required to
achieve some development milestone and, often without regard to how much that is, equate
that amount to 50 to 60 percent of the company (fully diluted for employee shares — see
Employee Stock Plans below). The best way to find out how your company is likely to be
valued is to look at what valuations venture capitalists are giving to other companies at the
same development stage and in the same general market area.
Venture Capitalists will give your company a “pre-money” valuation based on its stage of
development. Your pre-money valuation is the price per share that they are offering you
times all of the outstanding stock, options and pool reserved for future employees. When
discussing a pre-money valuation, remember to clarify the size of pool contemplated by the
venture capitalists. Adequate shares for one year is typical. After the venture funding, your
“post money” valuation is easy to determine. Just multiply the fully diluted outstanding
capital of your company by the price per share paid by the last round investors.

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The Structure of a Typical Venture Financing
Why Have Preferred Stock?
Companies typically sell convertible preferred stock to venture investors at a substantial
premium over the price charged to the founders or the seed investors. At a minimum, the
preferred stock gives the investors a liquidation preference in the event the company fails or
is acquired. In addition, they usually obtain certain other preferential rights over the holders
of common stock. From your company’s point of view, these preferences justify a fair market
value differential between the preferred stock and the common stock. This enables your
company to continue to sell common stock to your employees at a lower price than is paid by
the preferred investors.
Typical Preferred Stock Preferences
There are six basic types of preferences granted to preferred stock.
Liquidation Preference.  Upon liquidation of the company, the preferred stock has the
right to receive a fixed-dollar amount before any assets can be distributed to the holders of
common stock. Typically, the liquidation preference is the purchase price plus accrued but
unpaid dividends. A “participating” preferred stock also participates with the common stock
in the distribution of any assets left after payment of the liquidation preference. In addition
to actual liquidations, venture capitalists also want to receive their liquidation preference on
a company merger. This provision will give the preferred shareholders the right to receive at
least their original investment back in the event of a merger and sometimes a multiple return
on their money before the common shareholders will participate.
Dividend Preference.  Most preferred stock is given a dividend preference over the
common stock. There are two types of dividend preferences. A “when, as and if declared,
noncumulative” dividend preference means that the company cannot declare dividends
on the common stock until a specified dividend is paid on the preferred stock. By contrast,
a “mandatory, cumulative” dividend preference is more like an interest provision, since it
requires the company to set aside and pay dividends on the preferred stock at a designated
rate. Most high tech companies do not pay dividends, and by agreeing to mandatory,
cumula-tive dividends you may adversely affect your company’s cash flow and put it at a
competitive disadvantage. Mandatory dividends are not frequently used, but if they are, it is
usually in conjunction with mandatory redemption by investors.
Redemption.  There are two kinds of redemption provisions. An “optional” redemption
provision lets the company repurchase or redeem the preferred stock at its purchase price
plus a redemption premium. The company can thus force the preferred stock to convert to
common stock or face redemption. A “mandatory” redemption provision lets the investors
require the company to repurchase the investors’ preferred stock at its purchase price plus a
redemption premium. Investors may want the right to recover their initial investment, plus a
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profit, if the company fails to meet expectations. Companies dislike mandatory redemption
because the investment is more like debt than equity. Under current tax rules, excessive
redemption premiums can result in imputed income to the holder of the preferred stock even
if the premium is never paid by the company. To avoid this problem, it is prudent to follow the
IRS safe harbor provisions by limiting any redemption premium to 1/4 percent per year.
Conversion Rights.  Preferred stock issued in venture financings is almost always
convertible into common stock at the holder’s option. There is also a provision for
automatic conversion upon the initial public offering of the company’s stock or upon the
vote of a majority of the preferred stock. To encourage investors to support the company
when it is forced to raise money at a lower price than its previous round, you could have a
provision that automatically converts preferred stock to common if the holder declines to
purchase his or her pro rata share of a lower priced offering. This is referred to as a “pay
to play” provision. Another form of “pay to play” provision will have such holder’s shares
automatically convert to a “shadow” preferred — identical to the original series of pre-ferred,
but without antidilution protection. Typically, the preferred stock will be initially convertible
on a one-to-one ratio. The conversion ratio is actually calculated by taking the original
purchase price and dividing it by the conversion price. The initial conversion price is normally
the original purchase price. The conversion ratio is adjusted for dilutive events or issuances,
as discussed in Antidilution Protection below.
Antidilution Protection.  Convertible preferred stock always contains provisions protecting it
against dilution from stock splits and stock dividends, sometimes called “event protection.”
Frequently, there are also provisions protecting it against future sales of stock at lower
prices, called “price protection.” The most common price protection and that are most
favorable to your company is a “weighted-average” adjustment of the conversion price. The
weighted-average formula adjusts the conversion price by means of a weighted formula
based upon both the sale price and number of shares sold. There are two types of weighted
average antidilution: “broad based” and “narrow based.” Broad-based protection includes
preferred and options as well and stock dividends, sometimes called “event protection.”
Frequently, there are also provisions protecting it against future sales of stock at lower
prices, called “price protection.” The most common price protection and that are most
favorable to your company is a “weighted-average” adjustment of the conversion price. The
weighted-average formula adjusts the conversion price by means of a weighted formula
based upon both the sale price and number of shares sold. There are two types of weighted
average antidilution: “broad based” and “narrow based.”
Broad-based protection includes preferred and options as well as common stock in the
calculation and will result in a smaller adjustment if there is a “down” round of financing.
Narrow-based protection may exclude options or the preferred and is less favorable to the
company. If the investors think they are paying too much for the preferred, they may insist
on “ratchet” antidilution protection, which drops the conversion price to the most recent
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lower price at which stock was sold, regardless of how many shares were sold at that price.
This protects investors who decline to participate in lower-priced offerings. The second
scenario in Appendix A illustrates the effect of antidilution protection as converted to
common-percentage stock ownership. In both cases, you should ensure that employee stock
issuances and stock issued in mergers and lease financings are excluded from the definition
of “dilutive issuances.” Some venture capitalists won’t include price-based antidilution
protection so as to put more pressure on investors to support the company in bad times.
Voting Rights.  Preferred stock typically votes with the common stock, on an “as if
converted” into common stock basis. In addition, the preferred stock may be given the right
to elect a certain number of directors to the company’s Board of Directors, with the common
stock electing the remainder. Applicable corporate law also gives the preferred stock class
voting rights on certain major corporate events, such as mergers or the creation of senior
preferred stock. Investors may wish to expand the items requiring a separate class vote. It is
generally preferable to avoid series-voting rights since that gives a given series a veto right
over items that might otherwise be approved by the shareholders as a whole and by each
class of shareholders.
Registration Rights
In addition to the preferences discussed above, venture capitalists require an avenue to
liquidity. This is usually achieved by a registration-rights agreement giving the investors
the right to require your company to go public and register their shares with the SEC. These
registration rights are called “demand rights.” The investors may also have the right to
require your company to register their shares with the SEC when the company decides to go
public. These rights are referred to as “piggyback rights.” In both cases, the company usually
pays related expenses.
Typical Restrictions Imposed on Management
Venture capitalists generally require certain commitments from your company about its postfinancing management. The covenants that you are likely to encounter are affirmative and
negative covenants, rights of first refusal and co-sale rights.
Affirmative covenants generally require your company to provide the investors with ongoing
financial information and access to the company’s records and management and may grant
the investors the right to board representation or board visitation rights.
Conversely, investors may also require negative covenants or company agreements not
to take specified actions without the investors’ consent. Your management must carefully
evaluate these covenants to ensure that they will not unduly interfere with your board’s
ability to manage the company.

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Investors also may obtain a “right of first refusal” on further stock issuances by your
company. Typically, these provisions will give the investors the right to buy their
proportionate share of any new stock offerings prior to the public offering. You should avoid
a right of first refusal giving investors the right to buy all of a new issuance because that
could make it hard for the company to attract new investors. In addition, certain types of
offerings (such as stock issued in mergers, lease financings and to employees) should be
excluded from the investors’ right of first refusal.
In addition to these restrictions, the venture capitalists may require that the founders
personally sign a co-sale agreement. A co-sale agreement gives the venture capitalists the
right to participate in any proposed sale of the founder’s stock to third parties. The reason
for a co-sale agreement is that the investors generally do not want the founders to “cash out”
without giving the investors the same opportunity. Both the right of first refusal and co-sale
agreement should terminate upon a public offering or the company’s acquisition.

Employee Stock Plans
Companies typically establish employee stock option plans to provide equity incentives for
employees. Start-up companies are high risk and cash-flow constraints often mean that
employees may be asked to accept below-market salaries to conserve cash in the start-up
phase. Consequently, equity plans are essential to attract and retain top quality people in a
start-up. The number of shares reserved for employee plans is typically 10 to 20 percent of
the outstanding shares. It is typical for early stage companies (though not approved by the
IRS) to establish a fair market value for common stock for such employee plans within a range
of 10 to 20 percent of the most recent value of the preferred stock. This price differential must
disappear as you approach a public offering or acquisition of the company or the company
may be required to take a “cheap stock” charge to earnings by the SEC.

Corporate Partnering
As your company completes product development and moves into manufacturing and
distribution, you should consider structuring some kind of partnering arrangement with
one or more major corporations in your field. A strategic alliance with a major corporation
can sharply accelerate your growth by providing you with an established manufacturing or
distribution infrastructure, credibility, influence and immediate access to both domestic
and international customers. (See the Fenwick booklet on Corporate Partnering for High
Technology Companies for a detailed discussion on finding and negotiating partnering
arrangements.)

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When Should you Consider an Acquisition?
Many good companies discover after a number of years of effort that it is going to be difficult
(if not impossible) to attain the level of revenues and profits set forth in their initial business
plan. The product development cycle may be longer than anticipated, the market too small,
the barriers to entry too great, distribution channels may be clogged, the company may
not be able to develop follow-on products or the management team may not be up to the
challenge of growing the company beyond a certain size. While any of these difficulties may
restrict the company’s future growth, the company’s product or management team could still
be highly valuable in the hands of a strategic buyer. For such companies, an acquisition may
give investors a quicker and more certain path to liquidity. Alternatively, many technology
companies have used acquisitions of related products or companies as a means to accelerate
their own growth to the critical mass necessary for success. Since change seems to be the
only constant in the life of a high tech company, you need to keep an open mind about the
advisability of being acquired or acquiring other companies. (See the Fenwick booklet on
Mergers and Acquisitions for High Technology Companies for a detailed discussion on issues
and negotiating strategies in technology company acquisitions.)

Financing — the Second Round
At the next appropriate financing “window,” or as your company begins to run out of cash,
you may seek a second round of venture capital to start the next milestone of your business
plan or to adapt to changed market conditions. How much control you are able to exercise
during subsequent rounds of financing depends largely on how successful you have been in
managing the planned development and growth of the company with previous funding and
the degree to which investment capital is available.
Successful Companies
If your company has proven its ability to “execute” its business plan, you should be able
to raise money at a substantial premium over the first-round, perhaps one and one-half to
two and one-half or more times the first round price. The first-round venture investors will
participate in the second round financing, typically providing one quarter to one half of the
money in the second round. A lead investor representing the “new money” generally will set
the second-round price and its terms and conditions. If the company runs out of cash before
the lead investor is found, the current investors may “bridge” the gap by giving the company
a bridge loan that will automatically convert into the next round series of preferred stock.
Investors typically receive market rate interest and warrants for making bridge loans.
Unsuccessful Companies
If your company has fallen measurably short of its plan, finding new investors will be a
problem and your existing investors may need to fund a greater percentage of the round.
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Since the company will be in a weaker bargaining position, it may have to raise money at a
lower price than the first round, triggering antidilution protection and causing significant
dilution to the founders. More onerous preferred stock terms are likely, including pay-to-play
provisions, ratchet-antidilution protection and multiple-liquidation preferences. In addition,
the venture capitalists may force you to change management, replace the CEO, impose more
rigorous controls over the company’s management or force personnel layoffs.
When the existing investors lead a “down” round financing, it raises conflict of interest and
fiduciary duty issues since the investors who are pricing the deal offered to the company
are the same people who are approving the deal on the company’s board of directors.
Down-round financings should be structured to minimize the risk of liability to the board
and its investors and maximize the fairness to the company’s shareholders. For example,
the company should conduct a “rights offering,” permitting all company shareholders who
are qualified investors for securities law purposes to participate in the offering and it could
obtain an independent appraisal of the pre-money valuation of the company. Because downround financings raise so many legal issues, consult your corporate counsel on how to best
address these issues.

The Initial Public Offering
What are the Prerequisites for Going Public?
In order to go public, your company should establish a consistent pattern of growth and
profitability and a strong management team. Your company’s ability to go public will depend
on market factors, as well as the company’s revenue and profitability rate, its projections for
future revenue and profit and the receptivity of the securities market. When market interest
in technology is high, companies can be valued at levels that seem unrelated to their balance
sheets or income statements. There is enormous pressure on companies to go public during
these market windows. However, the IPO market is volatile and reacts to factors that are
outside your company’s control. Even if your company has met the profile described above,
you may find that the IPO market window is effectively closed. If that happens, your only
options may be self-funding, seeking additional venture funding or a sale to an established
company.
Advantages of Going Public
There are two principal advantages to going public. First, the company can raise a larger
amount of capital at a higher valuation than it could obtain from private investors because
“public” shares can be freely resold. Second, going public can boost your company’s sales
and marketing by increasing its visibility. From the individual’s point of view, some venture
capitalists and key managers may sell a small portion of their stock in the initial public
offering (IPO) or a follow-on offering, giving them liquidity.

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Beyond these advantages, the founders achieve a psychological sense of financial success.
Before the IPO, they owned shares with no market and no readily ascertainable price. After
the offering, the public market sets the price and provides them liquidity.
Disadvantages of Going Public
There are a number of disadvantages to going public. A public offering is expensive. For
example, if your company wanted to make a $40 million offering, the underwriters typically
would take a seven percent commission on the stock sold, and the legal, accounting and
printing fees would exceed $1.2 million. Once public, your company must publish quarterly
financial statements and disclose information you previously considered confidential. The
SEC is increasing the scope of information public companies must make available to the
public and holding the CEO and CFO responsible for the accuracy of the information provided
to the public. In making business decisions, your company’s Board of Directors will have to
consider the effect on the company’s stock price. Failing to meet analysts’ expectations can
lead to a dramatic drop in the company’s stock price. In a very real sense, entrepreneurs tend
to feel that they lose control of “their” company after the IPO.

Conclusion
For many high technology start-ups, a venture capital financing strategy is the only realistic
way that their new product ideas can be successfully developed and introduced into the
marketplace. Without the capital infusions and the management assistance of venture
capitalists, many of these companies’ products simply would not make it to the public
market. Entrepreneurs have an abundance of good ideas and the drive to realize them. The
management and market experience they may lack can be provided by the relationships they
develop with experienced venture capitalists, accountants and lawyers who focus in working
with high technology companies.

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Appendix A: Illustrative Financing Scenarios
In order to give you a better idea of what you can expect in the way of share ownership or
company valuation if you decide to pursue a venture capital financing strategy, we have
prepared two illustrative financing scenarios. Both assume that the company was able
to raise the necessary funding to develop and bring its product to market and that the
company’s product was ultimately accepted by the marketplace. The first scenario assumes
a strong, experienced founding team, with strong and continuous growth in product
development, marketing and sales, while the second assumes a less experienced team that
stumbles, but does not fail, in its objectives, but faces the effects of a down-round financing.
It is difficult to generalize about the percentage ownership founders may retain by their
company’s IPO. While these scenarios provide some realistic parameters, actual valuations
will depend on the attractiveness of the given investment and market conditions at the time.
Highly Successful Team
If you gathered a very strong management team, developed a product with strong market
acceptance and were both lucky and particularly successful at executing your business
plan, your company’s valuation round-by-round and the distribution of your company’s
outstanding shares at the IPO might be similar to that set forth below:
Shareholders

No. Shares

Purchace
Price

Dollars
Invested

Company
Valuation

% Ownership
at IPO

Founders
(Common)

4,250,000

$ 0.001

$ 4,250

$ 4,250

Seed Investors
(Preferred)

1,000,000

0.50

500,000

2,625,000

5

Round 1 Inv.
(Preferred)

3,500,000

2.00

7,000,000

17,500,000

18

Employees
(Common)

1,750,000

0.20

350,000

21,000,000

9

Round 2 Inv.
(Preferred)

5,000,000

4.50

22,500,000

69,750,000

26

Employees
(Common)

2,000,000

0.45

900,000

78,750,000

10

Public
(Common)

2,000,000

20.00

40,000,000

390,000,000

10

Total

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19,500,000

22 %

100 %

venture capital 20

Less Experienced Team
The scenario can be very different if you are unable to attract a highly experienced
management team. Inexperienced managers may fail to meet the intensive demands
of a high-growth start-up. For this scenario, we have assumed that the company fails
to complete product development on time and has to raise additional capital without a
completed product. As a result, two of the five founders are replaced with more experienced
management before the second round of venture financing. The number of founders’
shares at the IPO is less than in the first scenario because the company repurchased the exfounders’ shares on termination of employment. While more capital was needed to complete
the product and launch it into the market, the second round financing was done at a lower
price per share than the first round because the company had not yet removed the product
development risk and the doubts that created about management. In addition, the “As
Converted Ownership % @ IPO” column reflects the effect of ratchet or weighted-averageantidilution protection triggered by the “down” round. After the “down” round of financing,
the company is then able to get back on track and raise the additional private capital needed
at a step-up in valuation. The additional dilution from the lower valuation of the round two
financing and the resulting increase in the number of shares of common stock into which the
round one preferred stock will convert, dilutes the founders’ percentage ownership far more
than in the first scenario. Under this scenario, the company’s valuation round-by-round and
the distribution of the company’s outstanding shares at the IPO might be similar to that set
forth below:
Shareholders

No. Shares Purchace
Price

Dollars
Invested

Company
Valuation

% Ownership
at IPO (no Antidilution protection)

As Converted
Ownership % at
IPO
Ratchet

Weighted
Average

21 venture capital

Founders
(Common)

2,000,000

$ 0.001

$ 2,000

$ 2,000

6.8%

6.1 %

6.5%

Seed Investors
(Preferred)

1,000,000

0.50

500,000

1,500,000

3.4

3.1

3.3

Round 1 Inv.
(Preferred)

3,500,000

2.00

7,000,000

13,000,000

11.9

21.3

15.7

Employees
(Common)

1,750,000

0.20

350,000

16,500,000

6.0

5.3

5.7

Round 2 Inv.
(Preferred)

0,000,000

1.00

10,000,000

18,250,000

34.1

30.5

32.6

Employees
(Common)

1,750,000

0.20

350,000

20,000,000

6.0

5.3

5.7

Round 3 Inv.
(Preferred)

6,000,000

4.00

24,000,000 104,000,000

20.5

18.3

19.6

Public
(Common)

3,333,334

12.00

40,000,000 352,000,008

11.4

10.2

10.9

Total:

9,333,334

100 %

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Appendix B: Series B Preferred Stock Term Sheet
Amount of Financing: $7,000,000
Type of Security: 3,500,000 shares of Series B Preferred Stock (“Series B Preferred”)
Purchase Price: $2.00 per share (a $14 million pre-money company valuation)
Projected Postfinancing

Number of Shares

%

4,250,000

40%

Capitalization:
Common Stock
Series A Preferred

1,000,000

10%

Series B Preferred

3,500,000

33%

Employee Options

1,750,000

17%

10,500,000

100%

Total:
Rights and Preferences of Series B Preferred

Dividend Rights  The holders of the Series A and Series B Preferred Stock (collectively the
“Preferred Stock”) shall be entitled to receive, out of any funds legally available therefore,
dividends at a rate of eight percent per year (i.e., $.04 and $.16 per share for the Series A
and B Preferred, respectively) prior and in preference to any payment of any dividend on
the Common Stock. Such dividends shall be paid when, as and if declared by the Board of
Directors and shall not be cumulative.
Liquidation Preference  In the event of any liquidation, dissolution or winding up of the
Company, the holders of the Preferred Stock will be entitled to receive an amount equal
to their original issue price per share, plus an amount equal to all declared but unpaid
dividends thereon (the “Preference Amount”). If there are insufficient assets to permit the
payment in full of the Preference Amount to the preferred shareholders, then the assets of
the Company will be distributed ratably to the holders of the Preferred Stock in proportion to
the Preference Amount each holder is otherwise entitled to receive.
After the full Preference Amount has been paid on all outstanding shares of Preferred
Stock, any remaining funds and assets of the Company legally available for distribution to
shareholders will be distributed ratably among the holders of the Preferred and Common
Stock on an as-converted basis.
A merger or consolidation of the Company in which its shareholders do not retain a majority
of the voting power in the surviving corporation, or sale of all or substantially all the
Company’s assets, will be deemed to be a liquidation, dissolution or winding up.
Conversion Right  The holders of the Preferred Stock shall have the right to convert the
Preferred Stock at any time into shares of Common Stock. The initial conversion rate for each
series of Preferred Stock shall be 1-for-1.
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venture capital 22

Automatic Conversion  The Preferred Stock shall be automatically converted into Common
Stock, at the then applicable conversion rate, upon the closing of an underwritten public
offering of shares of Common Stock of the Company at a public offering price of not less than
$6.00 per share and for a total public offering amount of not less than $10 million.
Antidilution Provisions  Stock splits, stock dividends and so forth shall have proportional
antidilution protection. The conversion price of the Preferred Stock shall be subject to
adjustment to prevent dilution on a weighted average basis in the event that the Company
issues additional shares of Common Stock or Common Stock Equivalents at a purchase
price less than the applicable conversion price; except that shares of Common Stock sold
or reserved for issuance to employees, directors, consultants or advisors of the Company
pursuant to stock purchase, stock option or other agreements approved by the Board and
certain other issues customarily excluded from triggering antidilution adjustments may be
issued without triggering antidilution adjustments.
Voting Rights  Each share of Preferred Stock carries a number of votes equal to the number
of shares of Common Stock then issuable upon its conversion into Common Stock. The
Preferred Stock will generally vote together with the Common Stock and not as a separate
class except that, with respect to the election of the Board of Directors, the holders of
Preferred Stock may elect three of the five members of the Board. The holders of the Common
Stock, voting together as a single class, shall be entitled to elect the two remaining Board
members.
Board Representation  At the Closing Date, the Board of Directors shall consist of Joe CEO,
Industry Luminary, Bill VC, Tom VC and Michele VC.
Protective Provisions  Consent of the holders of a majority of the outstanding Preferred
Stock shall be required for: (i) any action that materially and adversely alters or changes
the rights, preferences or privileges of any series of Preferred Stock; (ii) any action that
authorizes or creates shares of any class of stock having preferences superior to or on a
parity with any series of Preferred Stock; (iii) any amendment of the Company’s Articles of
Incorporation that materially and adversely affects the rights of any series of the Preferred
Stock; (iv) any merger or consolidation of the Company with or into one or more other
corporations in which the Company’s shareholders do not retain a majority of the voting
power in the surviving corporation or (v) the sale of all or substantially all the Company’s
assets.
Rights of First Refusal  So long as an investor holds at least five percent of the Company’s
outstanding capital, that holder of Preferred Stock shall be given the right of first refusal to
purchase up to its pro-rata portion (based on its percentage of the Company’s outstanding
common shares, calculated on an as-if-converted basis) of any equity securities offered
by the Company (other than shares offered to employees, in a merger or in connection
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with a lease line or line of credit, etc.) on the same terms and conditions as the Company
offers such securities to other potential investors. This right of first refusal will terminate
immediately prior to the Company’s initial underwritten public offering of its Common Stock
at a public offering price of not less than $6.00 per share and for a total public offering
amount of not less than $10 million.
Information Rights  So long as an investor continues to hold at least 5 percent of the
Company’s outstanding Common Stock (calculated on an as-converted basis), the Company
shall deliver to the investor: (i) audited annual financial statements within 90 days after the
end of each fiscal year; (ii) unaudited quarterly financial statements within 45 days of the
end of each fiscal quarter and (iii) unaudited monthly financial statements within 30 days of
the end of each month. These information rights shall terminate upon the Company’s initial
public offering.
Registration Rights 
(1) Demand Rights  If at any time after the third anniversary of the closing holders
of at least 30 percent of the “Registrable Securities” (defined below) request that
the Company file a registration statement covering the public sale of Registrable
Securities with an aggregate public offering price of at least $5 million, then the
Company will use its best efforts to cause such shares to be registered under the
Securities Act of 1933 (the “1933 Act”); provided, that the Company shall have the
right to delay such registration under certain circumstances for up to 90 days during
any 12-month period. “Registrable Securities” will mean the Common Stock issuable
on conversion of the Preferred Stock.

The Company shall not be obligated to effect more than two registrations under this
demand right provision and shall not be obligated to effect a registration during the
six-month period commencing with the date of the Company’s initial public offering
or any registration under the 1933 Act in which Registrable Securities were registered.

(2) Piggyback Rights  The holders of Registrable Securities shall be entitled to
“piggyback” registration rights on all 1933 Act registrations of the Company or on any
demand registration (except for registrations relating to employee benefit plans and
corporate reorganizations).
(3) Cutback  The investors’ registration rights are subject to the right of the Company
and its underwriters to reduce the number of shares proposed to be registered pro
rata in view of market conditions. The underwriters’ “cutback” right shall provide
that at least 25 percent of the shares included in the Registration must be Registrable
Securities (except for the Company’s initial public offering, from which all Registrable
Securities may be excluded).

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venture capital 24

(4) S-3 Rights  Investors shall be entitled to registrations on Form S-3 (if available
to the Company) unless: (i) the aggregate public offering price of all securities of
the Company to be sold by shareholders in such registered offering is less than
$500,000; (ii) the Company certifies that it is not in the Company’s best interests to
file a Form S-3, in which event the Company may defer the filing for up to 90 days
once during any 12-month period or (iii) if the Company has already effected two
registrations on Form S-3 during the preceding 12 months.
(5) Expenses  The Company shall bear the registration expenses (exclusive of
underwriting discounts and commissions, but including the fees of one counsel for
the selling shareholders) of all such demand and piggyback registrations and for the
first S-3 registration.
(6) Transfer of Rights  Registration rights may be transferred to (i) transferees acquiring
at least 100,000 shares of Registrable Securities with notice to and consent of the
Company or (ii) any partner, shareholder, parent, child or spouse of the holder or to
the holder’s estate.
(7) Market Standoff  No holder will sell shares within such period requested by the
Company’s underwriters (not to exceed 180 days) after the effective date of the
Company’s initial public offering; provided, however, that such restriction does
not apply to Registrable Securities included in such registration statement; and
provided further, that all officers, directors and holders of more than 1 percent of the
outstanding capital stock of the Company enter into similar standoff agreements with
respect to such registration.
(8) Cross-Indemnification Provisions  The parties will provide each other with
reasonable cross-indemnification.
(9) Termination  The registration rights will terminate five years after the closing of the
Company’s initial public offering and will not apply to any shares that can be sold in a
three-month period pursuant to Rule 144 without registration.
Board of Directors  The Articles of Incorporation and Bylaws shall provide for a five-person
Board of Directors.
Stock Purchase Agreement  The investment shall be made pursuant to a Stock Purchase
Agreement reasonably acceptable to the Company and the investors, which agreement shall
contain, among other things, appropriate representations and warranties of the Company,
covenants of the Company reflecting the provisions set forth herein, and appropriate
conditions of closing, including an opinion of counsel for the Company. The Stock Purchase
Agreement shall provide that it may be amended by or that provisions may be waived only
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with the approval of the holders of a majority of the Series B Preferred (and/or Common
Stock issued upon conversion thereof). Registration rights provisions may be amended with
the consent of the holders of a majority of the Registrable Securities.
Stock Vesting  Stock sold and options granted to employees will be subject to the following
vesting, unless otherwise approved by the Board of Directors: (i) Vesting over four years
— 24 percent of the shares vest at the end of the first year, with two percent of the shares
vesting monthly thereafter; or (ii) Upon termination of the shareholder’s employment, with
or without cause, the Company shall retain the option to repurchase at cost any unvested
shares held by such shareholder.
Restrictions on Sales  The investors will make the customary investment representations.
Invention Assignment  Agreement: Each officer and employee of the Company shall have
entered into an acceptable confidentiality and invention assignment agreement.
Finders  The Company and the investors shall each indemnify the other for any finder’s fees
for which either is responsible.
Legal Fees and Expenses  The Company shall pay the reasonable fees and expenses of
Investors’ counsel up to a maximum of $30,000.

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venture capital 26

About the Author
Jacqueline A. Daunt retired from Fenwick & West LLP in 2003 after more than 21 years
in the firm’s Corporate Group. Her practice focused on representing high technology
clients in domestic and international transactions, including venture financings, mergers
and acquisitions, partnering arrangements, distribution and licensing agreements and
international protection of proprietary rights. Ms. Daunt received her B.A. in economics
and her J.D. from the University of Michigan. She also attended the Université Libre de
Bruxelles and L’Institut D’Études Européennes, where she studied comparative commercial
law and European antitrust law. In addition to frequent speaking engagements, Ms. Daunt
has authored during her career a series of booklets on strategic issues for high technology
companies, including Venture Capital, Corporate Partnering, Mergers and Acquisitions,
Structuring Effective Earnouts, International Distribution and Entering the U.S. Market. Ms.
Daunt’s booklets have been distributed to tens of thousands of entrepreneurs, students,
venture capitalists and journalists and are widely regarded as the most useful and
straightforward reference materials of their type. Fenwick is deeply indebted to Ms. Daunt for
her tireless efforts in writing and maintaining these invaluable resources.

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Trends in Terms of Venture Financings
in the San Francisco Bay Area
Fourth Quarter 2006

fenwick & west llp

Trends in Terms of Venture Financings
in the San Francisco Bay Area
(Fourth Quarter 2006)

Background
We analyzed the terms of venture financings for 113 technology companies headquartered in the San Francisco Bay Area that reported raising
money in the fourth quarter of 2006.
Overview
The results of the 4Q06 survey showed a continuation of the strong positive trend in venture valuations. The highlights of the quarter were
as follows:
• Up rounds exceeded down rounds for the twelfth quarter in a row (67% up vs. 22% down, with 11% flat).
• The Fenwick & West Venture Capital Barometer showed a 69% average price increase for companies receiving venture capital in 4Q06
compared to such companies’ previous financing round. This was the largest increase since the survey began. This increase was
driven in significant part by nine 4Q06 financings in which the purchase price of the stock sold in the financing was at least three times
higher than the prior round. Of these nine financings, most were Web 2.0 and related fields.
Other U.S. venture industry related results for the quarter and the year included the following:
• The amount invested by venture capitalists in the U.S. in 4Q06 was approximately $5.8 billion. Although this amount was
approximately 15% less than the amounts invested in 3Q06 and 2Q06, it fell solidly within the $5-7 billion quarterly range seen since
the end of 2003. Overall the amount invested by venture capitalists in the U.S. in 2006 was up approximately 8% over 2005.1
• Acquisitions of venture backed companies in the U.S. fell in 4Q06 with 75 transactions totaling $7.3 billion, compared to 112
transactions totaling $7.7 billion in 3Q06. However 2006 in general was the best acquisition year for venture backed companies since
2000, both in terms of aggregate amount paid ($31.2 billion) as well as median amount paid per transaction ($52 million).1
• IPOs of venture backed companies improved noticeably in 4Q06, with 18 IPOs raising $1.2 billion in 4Q06. 2006 was the second best
IPO year since 2000, with 56 venture backed IPOs raising $3.7 billion.1
• Healthcare companies had another good year, with venture investment increasing to $8.25 billion, up 12% over 2005, and the industry
accounting for 28 of the 56 IPOs. Information services (which includes Web 2.0 companies) also had a good year with investment
increasing to $2.4 billion, up 27% from 2005. Alternative energy had a substantial increase in activity with investment at $537 million
being close to three times higher than 2005.1
• Nasdaq was up 2.0% in 4Q06, was up 9.5% for 2006, and is up 3% in 1Q07 to date.
Price Change
The direction of price changes for companies receiving financing this quarter, compared to their previous round, were as follows:

Up Rounds
67%

67%

69%

74%

Down Rounds

69%
60%

65%

Flat Rounds

59%

22%

24%

25%

25%
15%

Q4’06 Q3’06 Q2’06 Q1’06 Q4’05 Q3’05 Q2’05 Q1’05

31%

31%

19%

11%

Q4’06 Q3’06 Q2’06 Q1’06 Q4’05 Q3’05 Q2’05 Q1’05

9%

6%

11%

12%

15%

4%

10%

Q4’06 Q3’06 Q2’06 Q1’06 Q4’05 Q3’05 Q2’05 Q1’05

The percentage of down rounds by series were as follows:

Series
B
C
D
E and higher
fenwick & west

Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

6%
15%
42%
53%

13%
24%
38%
33%

16%
32%
14%
57%

12%
12%
27%
12%

10%
5%
46%
35%

16%
35%
33%
23%

12%
32%
37%
60%

19%
36%
30%
62%

venture financing terms survey—4th quarter 2006

The Fenwick & West Venture Capital Barometer™ (Magnitude of Price Change) –Set forth below is (i) for up rounds, the average per share
percentage increase over the previous round, (ii) for down rounds, the average per share percentage decrease over the previous round, and
(iii) the overall average per share percentage change from the previous round for all rounds taken together. Such information is broken down
by series for 4Q06 and is provided on an aggregate basis for comparison purposes for the prior five quarters. In calculating the “net result”
for all rounds, “flat rounds” are included. For purposes of these calculations, all financings are considered equal, and accordingly we have not
weighted the results for the amount raised in a financing.
Q4’06
Percent
Change

Series B

Series C

Series D

Up
rounds

+152%

+113%

+46%

Down
rounds

-42%

-33%

+124%

+82%

Net
result

Series
E and
higher

Combined
total for
all Series
for Q4’06

Combined
total for
all Series
for Q3’06

Combined
total for
all Series
for Q2’06

Combined
total for
all Series
for Q1’06

Combined
total for
all Series
for Q4’05

Combined
total for
all Series
for Q3’05

+32%

+119%

+86%

+69%

+95%

+81%

+88%

-59%

-53%

-49%

-35%

-57%

-49%

-56%

-60%

+9%

-15%

+69%

+49%

+34%

+64%

+45%

+38%

Financing Round – The financings broke down according to the following rounds:
Series

Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

A

22%

23%

14%

11%

22%

18%

15%

24%

B

31%

31%

34%

40%

35%

31%

26%

29%

C

23%

24%

28%

17%

17%

23%

27%

16%

D

11%

17%

16%

15%

11%

15%

21%

22%

E and higher

13%

5%

8%

17%

15%

13%

11%

  9%

Liquidation Preference – Senior liquidation preferences were used in the following percentages of financings:
57%
50%

50%

The percentage of senior liquidation preference by series was as follows:

46%
40%

Q4’06

42%

Q3’06

40%

Q2’06

Series

41%

Q1’06 Q4’05

Q3’05

Q2’05

Q1’05

Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

B

23%

30%

35%

29%

22%

42%

25%

38%

C

38%

41%

76%

47%

40%

48%

40%

57%

D

58%

57%

36%

60%

69%

87%

68%

55%

E and
higher

67%

67%

57%

41%

65%

77%

70%

62%

Multiple Liquidation Preferences –The percentage of senior liquidation preferences that were multiple preferences were as follows:
Of the senior liquidation preferences, the ranges of the multiples broke down as follows:
30%
26%

14%

24%

16%

14%

Q4’06 Q3’06 Q2’06 Q1’06

Range of
multiples

22%

12%

Q4’05

Q3’05

Q2’05

Q1’05

venture financing terms survey—4th quarter 2006

Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

>1x – 2x

40%

90%

83%

80%

67%

93%

88%

100%

>2x – 3x

60%

10%

0%

20%

33%

  7%

  0%

   0%

0%

0%

17%

  0%

  0%

  0%

12%

   0%

> 3x

fenwick & west

Participation in Liquidation – The percentages
of financings that provided for participation
were as follows:
73%

71%

64%

64%

Q3’06 Q2’06 Q1’06

Q4’06

73%

71%

70%

65%

64%

Of the financings that had participation, the percentages
that were not capped were as follows:

Q4’05 Q3’05 Q2’05

Q4’06

Q1’05

64%

58%

55%

Q3’06

Q2’06

Q1’06

54%

50%

Q4’05

Q3’05

60%
51%

Q2’05

Q1’05

Cumulative Dividends – Cumulative dividends were provided for in the following percentages of financings:
Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

4%

7%

8%

3%

4%

3%

4%

9%

Antidilution Provisions – The uses of antidulition provisions in the financings were as follows:
Type of Provision
Ratchet
Weighted Average

Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

4%

4%

2%

4%

9%

7%

8%

9%

95%

95%

97%

92%

85%

92%

88%

87%

1%

1%

1%

4%

6%

1%

4%

4%

None

Pay-to-Play Provisions – The use of pay-to-play provisions in the financings was as follows:
Percentages of financings having pay-to-play provisions.
Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

10%

10%

16%

11%

16%

8%

16%

17%

The pay-to-play provisions provided for conversion of non-participating investors’ preferred stock into common stock or shadow preferred stock,
in the percentages set forth below:

- Common Stock
Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

73%

50%

86%

73%

89%

88%

87%

93%

- Shadow Preferred Stock
Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

27%

50%

14%

27%

11%

12%

13%

7%

Redemption – The percentages of financings providing for mandatory redemption or redemption at the option of the venture
capitalist were as follows:
Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

22%

29%

33%

27%

31%

32%

29%

30%

Corporate Reorganizations – The percentages of post-Series A financings involving a corporate reorganization were as follows:
Q4’06

Q3’06

Q2’06

Q1’06

Q4’05

Q3’05

Q2’05

Q1’05

6%

5%

12%

9%

11%

17%

15%

13%

For additional information about this report please contact Barry Kramer at 650-335-7278; bkramer@fenwick.com or Michael Patrick at 650-335-7273;
mpatrick@fenwick.com at Fenwick & West. To be placed on an email list for future editions of this survey please go to www.fenwick.com/vctrends.htm.
The contents of this report are not intended, and should not be considered, as legal advice or opinion.
1

Information in this paragraph obtained from Dow Jones VentureSource.

© 2007 Fenwick & West LLP

fenwick & west

venture financing terms survey—4th quarter 2006

Explanation of Certain Terms Used in
Venture Financing Terms Survey

this supplement to the fenwick & west venture financing terms survey explains the
meaning of key terms used in the survey.
Common Stock
Common stock is the basic equity interest in a company. It is typically the type of stock held by founders and
employees.
Preferred Stock
Preferred stock has various “preferences” over common stock. These preferences can include liquidation
preferences, dividend rights, redemption rights, conversion rights and voting rights, as described in more detail
below. Venture capitalists and other investors in private companies typically receive preferred stock for their
investment.
“Series” of Preferred Stock
When a company raises venture capital in a preferred stock financing, it typically designates the shares of
preferred stock sold in that financing with a letter. The shares sold in the first financing are usually designated
“Series A”, the second “Series B”, the third “Series C” and so forth. Shares of the same series all have the same
rights, but shares of different series can have very different rights.
Liquidation Preference
“Liquidation preference” refers to the dollar amount that a holder of a series of preferred stock will receive prior
to holders of common stock in the event that the company is sold—or the company is otherwise liquidated and its
assets distributed to stockholders. For example, if holders of preferred stock have a liquidation preference equal to
$30 million and the company is sold, they will receive the first $30 million before common stockholders receive any
amounts. The liquidation preference amount can be paid in cash or stock of an acquiror.
Senior Liquidation Preference
A series of preferred stock has a “senior” liquidation preference when it is entitled to receive its liquidation
preference before another series of preferred stock. All series of preferred stock will, of course, be “senior” to the
common stock simply by virtue of having a liquidation preference. For example, if the Series B has a $30 million
senior liquidation preference and the Series A has a $25 million liquidation preference and the company is sold
for $40 million, the Series B will receive $30 million and the Series A will receive $10 million.
Multiple Liquidation Preference
The amount of liquidation preference that a given series of preferred stock has is usually equal to the amount
paid for the stock. However, in certain financings new investors may require that their liquidation preference
amount be equal to more than the amount they originally invested—often referred to as a “multiple” liquidation
preference. Multiples tend to be one and one-half to three times the purchase price. A multiple liquidation
preference will almost always also be a senior liquidation preference as well. For example, if the Series B was
purchased for $30 million, but has a senior liquidation preference equal to two times the purchase price, then
the Series B investors will receive the first $60 million on any sale of the company before the Series A or common
stockholders receive any amounts.
Participation
Preferred stock is said to “participate” or to have “participation” rights when, after the holders of preferred stock
receive their full liquidation preference amount, they are then entitled to share with the holders of common stock
in the remaining amount being paid for the company, or otherwise distributed to stockholders.

For example, if the company is sold for $200 million, the preferred stock has a liquidation preference of
$30 million and the preferred stock represents 40% of the total number of outstanding shares of the company,
then the $200 million would be distributed among stockholders as follows:
1. First $30 million­­—paid to holders of preferred stock per their liquidation preference
2. Remaining $170 million:

n

Preferred stock holders receive their 40% pro rata share ($68 million) per their participation rights

n

Common stock holders receive remaining 60% ($102 million)

Totals:

Preferred stock holders— $98 million

Common stock holders— $102 million

Capped Participation
Participation rights are described as “capped” when the participation rights of the preferred stock are limited so
that the preferred stock stops participating in the proceeds of a sale, or other distribution, after it has received
back a pre-determined dollar amount—caps typically range from three to five times the original amount invested.
Building on the previous example, if the participation rights of the preferred stock were capped at a 3x multiple
of their liquidation preference amount—3x includes the amount of liquidation preference—then the result
would be that the preferred stock would receive only an additional $60 million in participation in step (2) above.
Thus, the total amount received by the holders of preferred stock would be $90 million—down from $98 million
without a cap—and the amount received by the holders of common stock would increase to $110 million—up from
$102 million.
Note: If the price paid for the company in this example were substantially higher (e.g., $275 million) then the
holders of preferred stock would convert to common stock, thereby giving up their liquidation preference, in order
to eliminate the 3x cap, because 40% of $275 million equals $110 million, which is $12 million more than the
preferred would receive if they did not convert and were subject to the 3x cap.
Cumulative Dividends
Holders of preferred stock having a cumulative dividend right are entitled to be paid, in addition to a liquidation
preference, an amount equal to a certain percentage per year of the purchase price for the preferred stock—
typically five to eight percent. For example, if the preferred stock purchase price was $20 million, and the stock
had a 1x liquidation preference and a six percent cumulative dividend, and if the company was sold after three
years, then the preferred stock holders would be entitled to $23.6 million before anything was paid on the
common stock. In some circumstances cumulative dividends must be paid annually, but this is unusual in venture
financed companies.
Conversion Rate
Almost all preferred stock issued in venture financings can be converted into common stock at the option of the
holder of preferred stock. The typical initial conversion rate is one share of preferred stock converts into one
share of common stock. However, the conversion rate can change for a number of reasons, such as stock splits or
antidilution adjustments.
Antidilution Provisions
Antidilution provisions retroactively reduce the per share purchase price of preferred stock if the company
sells stock in the future at a lower prices. This is effected by increasing the conversion rate of the preferred and
accordingly increasing the number of shares of common stock into which a share of preferred stock converts.
There are two main types of antidilution protection: weighted average antidilution protection and ratchet
antidilution protection.

Weighted Average Antidilution
Weighted average antidilution provisions, which are the milder form of antidilution protection, increase the
conversion rate of the preferred stock based on a formula that is intended to take into account the overall
economic effect of the sale of new stock by the company. The formula includes variables for the price at which
new stock is sold, the price at which the old preferred stock was sold, the total number of new shares issued and
the total number of shares outstanding.
Ratchet Antidilution
Ratchet antidilution provisions, which are the tougher form of antidilution protection, increase the conversion
rate of the preferred stock based on the price per share at which the company sells its stock in a future down
round, regardless of how few or how many new shares are sold at the lower price. This has the effect of
retroactively reducing the price per share that the preferred was sold in the current round to the new, lower
valuation of a future down round.
Pay to Play
Pay to play provisions impose penalties on investors for not investing their full pro rata share in the next
round—typically only if the next round is a down round. The more severe version of these penalties is to provide
that investors who do not invest their full pro rata amount will have their existing preferred stock converted into
common stock, resulting in the loss of their liquidation preference and antidilution protection, among other
rights. A less severe version is to convert the preferred stock into a different series of preferred often referred to
as “shadow preferred,” that retains some or all of its liquidation preference, but loses anti-dilution protection,
both for the subject financing and going forward.
Redemption
Redemption provisions allow investors to require the company to repurchase their preferred stock under certain
circumstances, typically for the price originally paid. Redemption rights usually cannot be exercised unless the
holders of at least a majority, sometimes more, of the preferred stock so request and usually cannot be exercised
for four to five years after the financing. In certain circumstances, redemption provisions may provide for a right of
exercise more quickly or for a repurchase at more than the original purchase price.
Corporate Reorganization
Corporate reorganizations typically refer to either (a) the conversion of existing preferred stock into common
stock, or into a new series of preferred stock with a substantially reduced liquidation preference amount and/or
(b) a reverse stock split of outstanding stock. Corporate reorganizations are usually implemented to reset the
economic interests of existing stockholders to current economic realities so as to facilitate the company’s ability
to attract additional investment and to provide appropriate incentive to the management team. The conversion
of existing preferred stock into common or a new series of preferred stock has a significant economic effect, as
those stockholders will often lose substantial liquidation preferences and other rights. A reverse stock split has no
economic effect in and of itself, but is usually undertaken when a company’s stock price has fallen significantly and
the company wants to raise it to a more typical range.
For additional information about this glossary please contact Barry Kramer at 650-335-7278; bkramer@fenwick.
com or Michael Patrick at 650-335-7273; mpatrick@fenwick.com at Fenwick & West. To be placed on an e-mail list
for future editions of the Fenwick & West Venture Terms Survey please go to www.fenwick.com/vctrends.htm.
Nothing in the foregoing glossary is intended to constitute legal advice or to establish an attorney-client
relationship between Fenwick & West (or the authors) and any other person. The circumstances of each venture
financing are different and persons involved in such financings are encouraged to seek independent legal advice
from counsel experienced in representing participants in such transactions.

Software Escrows as Part of an Intellectual
Property Strategy
by rajiv patel

Introduction

In what situations are software escrows
requested?

For many companies, a key aspect of a comprehensive
intellectual property strategy is to identify and enforce

Often, there is tension between the software developer’s

mechanisms to protect their investment in software

desire to keep source code confidential and out of the hands

purchased from software developers. One particular tool to

of the licensee and others who may gain possession of,

guard such investments is the software escrow.

or knowledge about, the source code, and the licensee’s
desire to have access to the source code in the event that

What is a software escrow?

the software is not longer available at agreed upon levels of
service.

A software escrow is a deposit of source code of software
and other materials with a third party escrow agent.

Examples of when a licensees generally request a software

Generally, a party licensing the software (the “licensee”

escrow include an established company integrating software

or “buyer”) requests the software escrow from the owner

from a small, relatively unproven company into its product

of the software (the “software developer” or “developer”)

or service offerings or a business integrating a developer’s

to ensure maintenance of the software and possibly

software into its business such that the business could be

performance of development obligations under a license.

halted if the software were suddenly unavailable or did not
perform to expectation.

Why does a software escrow exist?

Who is likely to agree to a software escrow?

Software developers typically make a significant portion of
their profit on recurring maintenance contracts instead of

Practically, smaller software developers are more likely to

the basic license fees. Often, software developers will even

agree to a software escrow than larger software developers.

forego basic license fees and focus instead on ensuring

Smaller software developers want to gain the trust and

that the licensee is captive for longer periods through the

confidence of larger companies in doing business with

use of maintenance contract, which may include services

them. Moreover, they seek to do this without exposing their

in addition to maintenance of the code itself. Thus, most

source code and associated intellectual property to the

developers offer software licenses that only license object

large company, for obvious business reasons of having the

code, i.e., the code that can be read by a machine, rather

endorsement of a larger client to attract other customers

than the source code, i.e., code that can be deciphered

or for having their products bundled with those of larger

and read by a person. Aside from leveraging maintenance

developers to go to an even larger end-user base.

contracts to develop longer term relationships with a
licensee, software developers also have a vested interest
in protecting the source code from risks that directly affect
the source code. Examples of such risk include copying

What types of risks does a licensee seek to
minimize by a software escrow?

or reverse engineering the code to develop a competing
product or unauthorized modifications to the source code

Generally, are three types of risks that drive creation of a

that may affect performance or operation of other parts

software escrow. The first risk is that the software developer

of the code. On the flip side, licensees reliant on such

substantially goes out of business or becomes financially

software developers want to ensure that their investment

unable to perform its development and support obligations.

in the developer’s software is protected and not lost if the

The software developer does not yet file for bankruptcy

developer fails to fix bugs or the like. Hence, such licensees

and still exists as an entity, but fails to provide support or

want may need access to the source code in the event that

improvements to the software.

the software developer no longer provides the object code.

fenwick & west 

The second risk is that the software developer files for

The second risk to minimize is the risk of releasing the

bankruptcy and terminates the license in the case. Under the

source code from escrow. As a part of this risk assessment,

U.S. Bankruptcy Act, if reorganization occurs in a Chapter

the software developer will need to maintain flexibility

11 bankruptcy the software developer is still in business,

on circumstances in which the source code would not be

and the software developer elects to continue performing

released from escrow due to appropriate business decisions.

its license obligations, there may be no significant impact

For example, if a software product reaches end of life, the

on the licensee of the Chapter 11. If, however, the software

escrow agreement should be structured so that it does not

developer ceases operations or otherwise fails to provide

trigger a release event, particularly, if there is an available

support at a previously agreed upon level with the licensee,

migration or upgrade path available to the licensee.

licensee will lose a vital part of its strategy regarding the
license software and, absent a triggered source code

How does a software escrow work?

escrow, may find itself unable to maintain and develop its
products.

Thanks to well established software escrow practices,
it is relatively easy to find a base framework creating

The third risk is that the software developer is acquired

a commercial software escrow particular for the needs

by a competitor of the licensee. In such situations, the

of a deal between two parties. Below are some basis

software may be altered to the detriment of the licensee,

considerations on what such frameworks include and where

discontinued, or support for it may be dropped altogether.

issues may arise.

An associated risk is a change in the relationship between
the software developer and the acquiring third-party. For

Identify a software escrow agent.

example, the acquiring third-party fails to provide support at

Initially, the software developer and the software

a level agreed upon with the software developer.

developer must agree upon a software escrow agent. Key
in determining who to select as a software escrow agent is

In summary, the risks above highlight for the licensee

that they are an independent third party unaffiliated with

the issue that business failure, however it occurs, creates

the software developer and that they have experience in

the problem that you either have to have the source code

administering source code escrows. Examples of established

deposits and rights to use them under the escrow or resort

software escrow agents include Iron Mountain Intellectual

to more expensive and less reliable approaches such as

Property Management, Inc., (www.ironmountain.com),

replacing it with another software component and the

SourceHarbor, Inc. (www.sourceharbor.com), and

consequent reengineering costs, or buying a new license

EscrowTech International, Inc. (www.escrowtech.com).

from anyone who comes into possession of the software
through acquisition without the support obligations under

Negotiate what goes into the software escrow.

the old licenses. Moreover, access to the source code and

The licensee should ensure that the complete source code

related remedies depend on licensee’s ability to replace the

of the licensed software goes into the escrow, along with

software developer’s services, for example, either through

associated materials such as documentation, software

doing it for itself or getting a third party to replace the

libraries, appropriate third-party items, and the like. The

software developer.

deposited source code should preferably be in electronic
format. In addition, the licensee should consider whether
the software developer should also include documentation

What type of risks does the software developer
seek to minimize?

such as development manuals and the like. In any event, the
rights to have possession and use of the deposit materials,
whatever they are, should depend on the agreement to

There are two primary risks that the software developer

deposit them, and not on actual deposit.

seeks to minimize through source code escrows. The first
is minimizing the risk of losing business. The software

Negotiate how often updates go into the software escrow.

developer can use the escrow to remove uncertainty in

The licensee should ensure that the software developer

business dealings between the licensee and them so that

is obligated to update its source code deposits with all-

the licensee feels comfortable in entering into a deal with

new versions, updates, and new releases of the licensed

the software developer.

software. Moreover, the obligation for these additional
deposits should be satisfied within a short time period after 

software escrows as part of an intellectual property strategy

fenwick & west

the initial distribution of the new version, update, or release.

The licensee should also consider other release events

Such time periods are typically within 30 days or less.

tied to the practicality of using the software developer for
continuing maintenance services. For example, the licensee

Confirm what went into the software escrow.

may use this release when the software developer seeks to

A key part of the escrow arrangement is ensuring that what

increase maintenance costs beyond a specified limit set in

goes into the escrow is what the licensee expects. Deposits

the maintenance contract.

of incomplete or out-of-date source code do happen, but can
be prevented. To avoid such problems, include provisions in

Next, avoid relying on “insolvency” as a release condition

the escrow agreement for deposit of new versions, updates

because its occurrence is difficult to determine with accuracy

and releases as previously described, in addition to the

and it is usually determined only in hindsight through

original deposit of code.

expensive litigation with delay. Finally, note that though the
release condition is common, software developer’s filing for

Determine release conditions from the software escrow.

bankruptcy is not an enforceable release condition.

A critical aspect of the software escrow is the release
provision. The release provision, typically referred to as the

Determine who pays for the software escrow.

release conditions, defines the conditions upon which the

Typically, the software developer will pay for the software

source code and associated materials are released by the

escrow, although this point is often negotiable between the

escrow agent to the licensee As a general matter, release

parties.

provisions should focus on identifiable, indisputable facts.
The easier it is to demonstrate the occurrence of a release
condition, the more quickly and cheaply the licensee

What are key issues faced by the licensee with
respect to a software escrow?

should be able to get access to the deposit materials. In
addition, release conditions must also legally enforceable,

The material (i.e., the source code itself) is never deposited,

an important factor in the context of bankruptcy proceedings

or only partially deposited, into the escrow.

(further described below).

The licensee should also watch for and monitor the escrow
account activity, which should include a description of what

Many source code escrows limit the release event to the

was deposited and when. In addition, consider a technical

situation in which the software developer has ceased

verification service offered by independent third parties,

doing business and, therefore, cannot maintain the

including some software escrow agents. These services

software. In this regard, licensee can also ask for conditions

verify the integrity of the deposited materials and can range

related to harbingers of impending failure for release: the

from simple tests that confirm the physical content of the

appointment of a receiver for software developer’s business,

media to actual compilation of the code to test functionally.

the making of a general assignment for the benefit of

The verification service can be helpful in ensuring that the

creditors (an alternative to bankruptcy liquidation), and

licensee receives complete and useful source code when the

the announcement to the public in general that software

release event occurs.

developer is ceasing operations, are examples of such
release conditions. Still another release consideration

The occurrence of release conditions is unclear or disputed.

to plan for is a software developer’s outright refusal to

Most escrow agreements allow the software developer to

perform, repudiation of the license, including rejection in

oppose the licensee’s release request when a release event

bankruptcy.

allegedly occurs. To address such conflicts, there are options
available to write into the release process of an escrow

A licensee may also consider attempting to procure

agreement to avoid litigation over source code. The most

additional release events tied to the software developer’s

common escrow provision to resolve a release in dispute

failure to perform its maintenance obligations in a timely

is arbitration. Most parties to an agreement prefer this

or effective manner, e.g., a consistent failure to respond to,

provision because it provides a quick, low-cost, and more

or correct, documented errors within a specified number

importantly, decisive alternative to litigation.

of days of their report by the licensee to the software
developer.

Another approach for disputed releases is to have decision
making executives for each party meet and resolve their
differences. In this context, the escrow agreement and the

fenwick & west

software escrows as part of an intellectual property strategy 

threat of a release act as catalysts to facilitate action and

the other party to a damages claim. If debtor is a software

dialogue between the two parties. Still another approach to

developer of certain types of intellectual property (and

resolve disputes is to write into the escrow agreement the

note the definition of intellectual property in Section 101 of

requirement that disputes be “expedited,” including setting

the Bankruptcy Code does not include trademarks, foreign

forth timetables to complete each step.

patents or foreign copyrights), and rejects the license, the
Congress also allows the licensee to retain certain rights

More influential licensees may be in a position to negotiate

to use the technology as it existed on the date of filing in

a release-on- demand clause in their escrow agreements.

exchange for paying royalties due under the agreement, AND

This clause instructs the software escrow agent to release

to have rights under “ancillary agreements,” which includes

deposit materials immediately after receiving a request from

the escrow agreement.

the licensee.
Section 365(e) generally disables certain contract clauses
The source code is not helpful in a vacuum.

and provisions in some non-bankruptcy law that permit

Ensuring that escrowed source code is complete and

the non-debtor’s termination of an agreement because of

useful does not guarantee that the licensee will be able

a debtor’s bankruptcy filing or its financial condition upon

to work with it. To address this issue, consider requesting

filing. These so-called ipso facto clauses are not enforceable

supporting documentation and a list of technical

in licenses where the debtor is a software developer. Hence,

maintenance personnel from the software developer that

special crafting is required for the escrow release triggers

can be included as part of the deposit. If the software

to be sure that if the license occurs, and the licensee makes

developer goes out of business, these employees may be

the Section 365(n) election, the escrow release will occurred

available as consultants after the release has occurred,

and be effective. Specifically, Section 365(n) grants the

helping to ensure that the licensee has access to support

licensee absolute entitlement to retain rights to intellectual

personnel familiar with the software. Be sure they are

property (despite the debtor-software developer rejection of

authorized to assist in the event of a trigger, despite any

the license agreement) with some conditions. The licensee

confidentiality agreements with software developer??

cannot also enforce exclusivity against the debtor or its
assignee if the license is exclusive, but it cannot compel

If supporting documentation or a list of technical

further performance (such as development or maintenance)

maintenance personnel is not provided, the licensee should

otherwise provided under the license. Therefore, when

be prepared to hire an outside consultant or dedicate

drafting agreements for the U.S. the licensee should

internal personnel to maintain the technology. Here, the

structure the licensing agreement to fall under the scope of

licensee’s goal would be to use the released source code

365(n).

to have the consultant maintain it for as long as needed
or until a suitable replacement technology is available. In

There are a number of things a licensee can do to increase

some instances, the licensee may desire to incorporate

the probability of having the agreement fall under the scope

a predetermined number of hours or costs that would

of 365(n), including using executory contracts (which include

be covered under the agreement as it relates to these

software licensing agreements) that call for continuous

consulting arrangements. Likewise, a software developer

performance over time by both sides. Because the rights

may desire to cap such hours or costs if they end up in the

that can be retained upon rejection are those which existed

agreement.

at the time of the bankruptcy petition, license grants must
be present grants, not those which spring into existence

The software developer is in bankruptcy.

upon bankruptcy. Specifically, escrow agreement should be

Bankruptcy is often the most complicated issues in

drafted as a present grant to use the escrowed materials and

structuring and enforcing an escrow agreement. It is

not just a license right becoming effective upon bankruptcy.

important to understand the underlying principles because

If the license makes the escrow agreement effective upon

the Bankruptcy Code interferes with the parties’ ability

bankruptcy, then that does not fall under the section of

to strike any bargain they want. Section 365 of the U.S.

the code that says the license must be in effect in order to

Bankruptcy Code gives debtor parties to “executory

be valid, e.g., reciting “software developer hereby grants”

contracts” (those with substantial performance remaining

instead of “software developer grants.”

on both sides at the time of filing) a choice of assuming and
finishing the contract or “rejecting” it, generally leaving 
software escrows as part of an intellectual property strategy

fenwick & west

The right to the deposit materials should also be without
regard to whether the software developer actually made the
deposit required under the license. That way, if the software
developer did not do so and the escrow is triggered, the
licensee will have a legal right to demand that the debtor
or its trustee hand over the materials. There may be
practical problems in such a situation, and escrows need
to be monitored for compliance to avoid them, but at least
licensee will have the legal rights to the materials and can
work with the debtor or his trustee to find them.
Finally, the parties need to be careful in their license to
differentiate which payments are for use of the licensed
software and related intellectual property and which for
maintenance. Licensees making the Section 365(n) election
must pay royalties required under the license to continue
using the intellectual property. If the license is not clear, the
licensee will end up litigating how much “royalty” must be
paid to continue its use rights under Section 365(n) without
the support and maintenance of the software developer.

Conclusion
Software escrows can be a vital part of a software
purchaser’s intellectual property plan and strategy. The
ability to access source code in the event of a software
developer being unable to further maintain supplied
software code can be critical for a licensee.

About the Author
Rajiv Patel (rpatel@fenwick.com) is a Partner in the
Intellectual Property and Patent Groups of Fenwick & West
LLP. Fenwick & West LLP is a high technology law firm
based in Silicon Valley, California and is on the web at
www.fenwick.com. Special thanks to Ralph Pais and Mark
Porter of Fenwick & West on their insights and input for this
article. Thanks also to Ric Sala of Iron Mountain Intellectual
Property, Inc., Bea Wray of SourceHarbor, Inc., and Jon
Christiansen of EscrowTech International, Inc. for their
perspectives.

fenwick & west

software escrows as part of an intellectual property strategy 

Legal FAQ: Introduction to Patent Law
by robin reasoner and charlene morrow

1. What is a patent?
A patent is a legal right to exclude others from practicing
the patented invention for a limited period of time in
exchange for disclosing the details of the invention to the
public. An owner of a United States patent can exclude
others making, using, offering for sale, or selling their
invention in the United States, importing their invention
into the United States, exporting a substantial portion of
the invention for assembly into the invention overseas,
or exporting components overseas that were especially
made or adapted for use in a system that infringes and
those components are not staple articles of commerce
suitable for substantial non-infringing use.
There are several different types of patents in the United
States. Utility patents are the most common, and they
cover processes, machines, articles of manufacture,
and compositions of matter. Design patents cover the
ornamental features (i.e., appearance) of a product.
Plant patents cover newly developed varieties of plants
provided they can be reproduced asexually.
2. What can be patented?
The United States Patent Law specifies the broad
categories of what can be patented. Any useful, new
and nonobvious process, machine, article that is made,
or chemical composition, or improvement of any of the
above can be patented. Business methods and software
can also be patented, but laws of nature and abstract
ideas cannot be patented. (For more information on
what “useful, new, and nonobvious” means, see “Is my
invention patentable?”.)
3. Is my invention patentable? What are the standards my
invention has to meet?
Not all inventions are patentable. In the United States,
an invention has to be useful, new, and not obvious. An
invention generally is assumed to be useful unless there
is some reason to believe that it will not work. It is new
if it differs from previously existing technology. It is
nonobvious if the differences from the previously existing
technology would not be obvious to ordinary practitioners
in the relevant technological field. Patentable inventions
need not be pioneering breakthroughs. A patent can be

obtained on modest improvements in existing technology
as long as the improvements are useful, new, and not
obvious.
4. How long does it take to get an issued patent?
The length of time it takes to obtain an issued patent
varies significantly depending on the technology area.
The backlog of patent applications filed with the United
States Patent and Trademark Office (“PTO”) and waiting
for examination is considerable. Some technology areas
are appreciably slower than others. For software and
financial inventions, the PTO predicts that the delay
between an application being filed and when an Examiner
reviews the patent application for the first time could
exceed five years. In other technology areas, such as
optics, an Examiner may review the patent application
within one to two years of the filing date. Typically, after
the Examiner has reviewed a patent application for the
first time, it may take one to two additional years of back
and forth communications with the Examiner to come
to an agreement as to the scope and wording of the
patent claims and get the patent issued. There are some
provisions for speeding up review when there is active
infringement by others of the invention.
5. What are the parts of a patent application?
A United States patent application typically contains
the following sections: Background, Summary of the
Invention, Brief Description of the Drawings, Detailed
Description, Claims, Abstract, and Drawings. These
sections are briefly described below.
The Background identifies and describes some of the
problems solved by the invention. This section may also
describe conventional solutions to the problems and the
shortcomings of such solutions. The Summary of the
Invention briefly describes the structure and operation
of at least one embodiment of the invention. The
Detailed Description describes in detail the structure and
operation of one or more embodiments of the invention.
From a legal perspective, it is essential that this section
adequately describes the invention, enables a person
skilled in the relevant art to make and use the claimed

fenwick & west 

invention, and describes the best mode known to the
applicant for carrying out the claimed invention. The
Claims identify the exact scope of the rights provided by
the patent. The Claims of a patent are analogous to the
legal description in a deed to real property. The Abstract
presents a one paragraph summary of the subject matter
described in the application. The Drawings illustrate the
structure and operation of the invention.
6. Is there anything less expensive or faster to file than a
full-blown patent application? What is a Provisional
Patent Application?
A United States provisional application can be filed when
there is either limited time or funding to prepare a full
non-provisional utility patent application, or when an
applicant wants to wait up to a year to see how the market
responds to technology to determine whether to proceed
with a full patent application.
A provisional application allows an applicant to get a U.S.
filing date without all the formal requirements of nonprovisional utility applications, such as claims, formal
drawings, an oath or declaration by the inventor, and
the higher filing fee. However, the provisional patent
application must still describe the invention with the
same level of detail that is required for utility patent
applications. The provisional application does not
receive a substantive examination by the PTO. Instead,
the applicant has up to 12 months to file a corresponding
complete application with claims. The priority date
established by the provisional filing only applies to
claims for which there was an enabling disclosure in the
provisional application.
Alternatively, inventors can submit Statutory Invention
Registrations to the United States PTO. Although these
documents are not patent applications and will not issue
as patents, they will be published by the PTO. Therefore,
they become available as prior art that may block others
from subsequently gaining patent rights to the disclosed
invention. Note that the tradeoff is that the publishing
inventor may be giving up their ability to protect the
invention under trade secret law.
7. Do you have to do a prior art search before applying for a
patent?
No, an applicant does not need to perform a prior art
search at any time during the patenting process. There is,
however, an obligation in the United States to disclose to 

legal faq: introduction to patent law

the PTO all material information known to the inventors,
and anyone else participating in the application process,
during the application process.
8. How does the PTO decide whether to issue a patent?
Once a patent application is filed with the United States
PTO, it is assigned to a patent examiner who works in
a specific area or areas of technology. Because of the
application backlog, one to five years may pass before the
examiner actually reviews the application. Typically, after
reviewing the application, the examiner sends an “office
action” to the patent attorney or agent involved in the
application, listing both objections as to the form of the
application and to the substance, often including citations
to previous patents and other prior art documents that the
examiner states raise questions about the patentability of
the claims presented to him or her.
A patent applicant can then respond in writing to the
office action, offering either arguments as to why the
objection should be withdrawn, or amendments to the
claims to address the objections raised by the examiner.
An applicant may also request an interview with the
examiner. The examiner may then either agree with
the reasoning in the response and “allow” the pending
claims, or send another office action with the same or
additional objections.
9. What happens if my patent claims are rejected by the
PTO?
If the applicant and the U.S. examiner reach an impasse
over an issue, the examiner issues a “final” action. The
applicant can then either appeal to a special board of the
PTO or decide not to pursue the argument. If the applicant
decides not to pursue the argument, the applicant can
either abandon the application or start the examination
process over by using various “continuation” procedures.
10. What is a restriction requirement in a patent
application?
A U.S. patent applicant is entitled to examination of one
invention per application. If two or more inventions are
claimed in a single application, the Examiner may issue
a “restriction requirement” that forces the Applicant to
select a single one of the inventions to be examined.
The claims to any other invention can be put into a
separate application, which if filed while the first
application is still pending, should be entitled to the
benefit of the filing date of the first application.

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11. What do the terms “patent pending” and “patent applied
for” mean?
Once a patent issues, one way the patentholder can
give notice of its patent rights is to mark products
incorporating the invention with the word “Patent” or
“Pat.” and the patent number. A patent notice must
typically be placed directly on the patented article,
unless such a marking is not physically feasible. Patent
marking is not mandatory but can help the patentee
accrue money damages if it pursues litigation against
patent infringers. Marking articles with the terms
“Patent Pending” or “Patent Applied For” has no legal
effect.
12. Can I keep the content of my patent application a secret
until it issues? When will a patent application publish?
Until recently, the United States PTO maintained patent
applications in strict secrecy until a patent issued.
However, the PTO now by default publishes patent
applications approximately 18 months from their original
priority date. An applicant can opt out of publication by
filing an appropriate request at the time the application
is filed. However, this option cannot be pursued (and
an existing request not to publish must be rescinded)
if the applicant pursues any international applications
that have a publication requirement, such as a PCT
application (discussed below).
Publication can be beneficial to the patent applicant,
as provisional enforcement rights for the period
between the dates of publication and patent grant are
potentially available, so long as the published claims are
substantially identical to the claims ultimately granted in
the patent.
However, if an application is not published and during
prosecution it appears that the PTO will not allow claims
or only allow extremely narrow claims, the applicant
can still decide to abandon the application in favor of
continued trade secret protection.

14. What types of activities before I file an application will
prevent me from being granted a patent?
An applicant must file a patent application before or
on the date of public use or disclosure anywhere in the
world in order to obtain patent rights in many foreign
countries.
In the United States, the answer is a bit more
complicated. The following table summarizes the types
of activities by an applicant or third party that can
prevent an inventor from being granted a patent on an
invention:
activity

time

Inventor

actor

abandoned the
invention

at any time

anywhere in the
world

Inventor

derived or stole
the invention from
third-party

before the date
of invention

anywhere in the
world

Inventor

patents the
invention in
another country

more than
one year
before filing
a US patent
application

outside the
U.S.

Anyone

patented or
described
the invention
in a printed
publication.
A reference
is a printed
publication if it is
made available
in tangible form
and accessible to
those interested
in the field.

more than one
year before
the filing date
of the patent
application

anywhere in the
world

Anyone

offered for sale,
sold, or publicly
used or disclosed
the invention

more than one
year before
filing date of
the patent
application

U.S.

Third-party

knew or used the
invention

before the date
of invention

U.S.

Third-party

patented or
described
the invention
in a printed
publication

before the date
of invention

anywhere in the
world

Third-party

filed a patent
application that
ultimately issues
as a patent, or
published a PCT
application in
English, that
describes the
invention.

before the date
of invention

anywhere in the
world

Third-party

invented the
invention and did
not abandon or
conceal it

before the date
of invention

U.S.

13. When are patent maintenance fees due?
U.S. maintenance fees on all utility patents that issue
from applications filed on or after December 12, 1980,
are due at 3.5, 7.5, and 11.5 years from the date the patent
is granted. These fees can be paid without a surcharge
up to six months before they are due. A six-month grace
period after the due date is available upon payment of a
surcharge. Failure to pay the current maintenance fee on
time may result in the patent expiring. 

legal faq: introduction to patent law

location

Even if the invention itself was not publicly disclosed,
known, or used, in any of the above ways, any
information that was publicly disclosed, known, or
used as set forth above will still bar a patent if it makes
the claimed invention obvious. The above chart is

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not exhaustive. Particularly since engaging in certain
activities may destroy the ability to patent an invention,
it is strongly recommended that you consult with legal
counsel prior to engaging in conduct concerning your
invention.
15. Can I change the content of my patent application after I
file it?
In the United States, an applicant can make only limited
changes to the patent application after it is filed. An
applicant can correct typographical errors, submit formal
versions of informal drawings, and amend the claims
if there is support for the claim amendments in the
originally filed patent application. No new information
can be added to a patent application after it is filed. If
you want to add new information or material to the
description of the invention, you must file a new patent
application that will lose the benefit of the earlier filing
date for at least the new information and material.
16. How do I correct a mistake in an issued patent?
If a clerical error was made by the United States PTO,
such as typographical errors made in printing the patent,
the PTO may issue a Certificate of Correction upon
the applicant’s request. Some minor typographical
errors made by the applicant may also be corrected by
submitting a request for a Certificate of Correction and a
fee.
A patent holder may request a “reissue” of a patent
to correct mistakes in the scope of the U.S. claims. A
reissue that broadens the claims must be filed within
2 years after the issuance of the patent. A reissue that
narrows the claims can be filed at any time during the life
of the patent.
A request by a patent holder or a third party for a
“reexamination” by the United States PTO can be made
if prior art is uncovered that raises a substantial new
question as to the patentability of the claims in the
issued patent. There are two types of reexamination
proceedings, each with their own rules. They are
increasingly popular as part of a litigation strategy. (See
patent litigation FAQ)
17. How do I obtain patent rights in foreign countries?
Patent rights are typically granted on a country-bycountry basis, and each country has its own rules
for determining what is patentable, which may differ
significantly from the U.S. rules.

and Japan, are parties to an international treaty known
as the Paris Convention. The Paris Convention gives
an applicant one year to file a corresponding patent
application in a member country and still obtain an
original U.S. priority date.
To obtain patent protection in countries that are not
members of the Paris Convention, a patent application
must be filed directly in those countries prior to the first
public disclosure or sale of the invention, unless there is
a legislative agreement with those countries that honors
the one-year grace period. For example, Taiwan is not
a member of the Paris Convention but has entered into
an agreement with the United States that recognizes the
grace period and grants priority rights based upon U.S.
filings.
In addition to the Paris Convention, there are other
international treaties that seek to harmonize patent
protection among countries. For instance, the
Patent Cooperation Treaty (PCT) provides a two-stage
examination process for applications: first at an
international level, and then in the individual countries
from which patents are sought. Filing a PCT application
only defers filing in the individual countries, and it does
not replace these filings and associated costs. The
principal reason for filing a PCT application is to defer
deciding in what countries to seek patent protection and
the expenses of regional or national patent filings. By
30 months from the earliest priority date asserted in
the PCT application, the applicant must file a regional
or national patent application in each country or region
where protection is sought. The applicant must satisfy
the requirements of the respective regional or national
patent office to actually obtain the patent.
Another treaty, the European Patent Convention,
established the European Patent Office (EPO) that
handles applications for over 30 European countries. A
single EPO application can be filed for protection in some
or all of those countries. The application is examined
by the EPO in any of the three official languages and,
if granted, the specification is translated into the
languages of the designated countries. There is an
additional fee for issuance of the patent in each selected
country.
If you have any questions about this memorandum,
please contact Robin W. Reasoner (rreasoner@fenwick.
com) or Charlene M. Morrow (cmorrow@fenwick. com) of
Fenwick & West LLP.

Most of the world’s industrialized countries, including,
for example, Australia, Canada, China, Germany, India, 

legal faq: introduction to patent law

fenwick & west

Developing a Patent Strategy
A Checklist for Getting Started
by rajiv patel

For many technology companies, developing a patent
strategy is an important component of the business
plan. However, for many the approach for developing a
patent strategy is more happenstance than execution of a
precisely defined plan. To help develop a patent strategy,
this document provides a checklist for getting organized in

q Identify team members that will lead the mining and
analysis process.
q Identify employees that create intellectual assets for the
company.
q Identify the intellectual assets. To help determine this,

preparation for developing a comprehensive patent strategy

gather and organize documented materials. Examples of

for the company.

documented materials include business plans, company
procedures and policies, investor presentations,

A. Business and Patent Portfolio Goals

marketing presentations and publications, product

Starting in the development phase, the patent strategy

specifications, technical schematics, and software

identifies the key business goals of the company. Clear

programs. It may also include contractual agreements

business goals provide a long-term blueprint to guide the

such as employment agreements, assignment and

development of a valuable patent portfolio. In particular, the

license agreements, non-disclosure and confidentiality

company should:

agreements, investor agreements, and consulting
agreements.

q List the business, technology, and product goals for the
company.
q Identify key industry players (competitors, partners,
customers).
q Identify technology directions (within company and
within industry).
q Determine whether a patent portfolio be used offensively
(i.e., asserted against others; revenue generation, etc.),
defensively (i.e., used as a shield or counterclaim against
others who file suit first), for marketing purposes (i.e.,
to show the outside world a portfolio to demonstrate
company innovation), or a combination of these.
q Meet with attorney to align goals, industry information,
technology information, and portfolio use core strategy.
B. Evaluation of Company Assets
The evaluation process begins by mining and analyzing
intellectual assets within the company. In this process,
a company organizes and evaluates all of its intellectual
assets, such as its products, services, technologies,
processes, and business practices. Organizing intellectual
assets involves working with key executives to align the
patent strategy with the business objectives. Here, the

q Identify the anticipated life span for each intellectual
asset.
q Identify the market for each intellectual asset.
q Identify products/product lines incorporating each
intellectual asset.
q Identify those intellectual assets best suited for patent
protection.
q Review risk analysis with attorney involving competitor
studies.
q Prepare budget for patent strategy and patent
procurement.
C. Procurement Phase
While the evaluation phase is in progress, the company
can move into the procurement phase. In the procurement
phase of the patent strategy, a start-up company builds its
patent portfolio to protect core technologies, processes, and
business practices uncovered during the evaluation phase.
Typically, a patent portfolio is built with a combination of
crown-jewel patents, fence patents, design-around patents,
and portfolio enhancing patents. Each patent may have a
unique value proposition for the company.

company should:

fenwick & west 

q Establish a budget for patent portfolio development.

q Determine risks and benefits of various enforcement
options (cease & desist; cross-license; etc.).

q Draft invention disclosures (see attorney for Invention
Disclosure Form).
q Critically evaluate each invention disclosure in the
context of the patent strategy.

The outline above gives a just one overview of a potential
patent strategy. With any patent strategy, some key
considerations will include commitment from all levels

q Weigh risks vs. reward of a prior art search.

of management and execution of the strategy once it is

q Evaluate benefits and risk of provisional vs. utility patent

develop a patent strategy will be reap many rewards for the

application with attorney.
q Forward invention disclosure to attorney for patent

assembled. Companies that take the time and effort to
time, money and effort spend early on as their business
continues to grow and prosper.

application drafting.
q Over time, determine whether to conduct further
competitive analysis to study industry trends and
technology directions and identify patent portfolio
coverage in view of same.
q Over time, evaluate risk vs. reward of studying patent
portfolios of competitors and other industry players to

Rajiv Patel (rpatel@fenwick.com) is a partner in the
intellectual property group of Fenwick & West LLP. His
practice includes helping companies develop, manage and
deploy patent portfolios. He is registered to practice before
the U.S. Patent and Trademark Office. Fenwick & West LLP
has offices in Mountain View, CA, San Francisco, CA and
Boise, ID.

identify how to further strengthen its patent portfolio.
D. Deployment Phase
A company that values its intellectual assets may set aside
time, money and resources to further enhance its patent
portfolio. To do this a company may move to the deployment
phase. The deployment phase may include licensing all
or part of a patent portfolio to others in the industry or to
alternative applications for the technology. Alternatively,
it may include asserting rights established by its patents,
such as through litigation. The deployment stage often
includes high-level management involvement. In this stage a
company should consider:
q Review patent portfolio to identify those assets that
company can sell for cash or use to spin out new
business.
q Study competitor products for infringement
considerations and determine risks vs. rewards of cease
and desist strategy or licensing strategy.
q Evaluate the strength of competitor patent portfolios to
access the potential for counter-attacks. 

developing a patent strategy — a checklist for getting started

fenwick & west

Fenwick & West Firm Overview
fenwick & west llp provides comprehensive legal services to high
technology and life sciences companies of national and international
prominence. more than 250 attorneys offer corporate, intellectual
property, litigation and tax services from our offices in mountain
view and san francisco, california.
Corporate Group
We service high technology and life sciences companies, from early start-ups to mature
public companies.
Start-Up Companies. We have represented hundreds of growth-oriented companies from
inception through maturity. Our attorneys understand what it takes to start with only an idea,
build a team, found a company, raise venture capital funding and grow a business. We have
represented many of the nation’s leading venture capital firms and do multiple deals each year
with companies financed by these market leaders.
Mergers and Acquisitions. We are ranked by MergerMarket as one of the top five most active
legal advisor in the U.S. for technology sector M&A. We understand the problems that arise
in technology company acquisitions and focus our efforts on issues that are of the most value
to the client. Our expertise spans the entire spectrum of high technology, from life sciences
to semiconductors, and our lawyers are equally adept at small private company transactions
and multi-billion dollar public transactions. Of particular importance to our high technology
client base is the extraordinary acumen of our due diligence mergers and acquisitions
teams in locating and documenting intellectual property holdings of buyers and sellers. For
clients involved in larger deals, our antitrust lawyers are experienced in working with the
Department of Justice and Federal Trade Commission in the pre-merger clearance process. We
understand the many issues that can mean the difference between a successful transaction
and a broken promise.
Public Offerings and Securities Law Compliance. Our extensive representation of emerging
companies has given us substantial depth of experience in public offerings. In recent years,
we have represented companies or investment banks in more than 100 initial public offerings,
which, combined, have raised over $7 billion dollars. We have helped our clients raise billions
more in follow-on debt and equity offerings. Our counseling practice for technology companies
regarding ongoing public securities law issues includes extensive Sarbanes-Oxley compliance
and board or audit committee counseling.
Strategic Alliances. For many high technology companies, the path to financing and
commercialization begins with their first collaboration or joint venture with an industry partner.
These agreements can often make or break a young technology company. We help clients
think through the business, intellectual property, tax and other legal issues that arise in their
corporate partnering transactions and joint ventures.

Executive Compensation. As an integral part of the corporate

a wide range of industries, we have exceptional depth and

practice, we counsel clients on a wide range of employee

breadth in the areas of the law critical to our high technology

benefits and compensation matters. We assist companies in

clients. Those clients are leaders in such sectors as software

establishing and administering employee benefit arrangements.

and programming; Internet and entertainment; computer

Our lawyers help define and structure stock or other equity

hardware; semiconductors and life sciences. We are regularly

plans and arrangements, as well as tax qualified and fringe

involved in significant cases involving intellectual property

benefit plans, that meet the companies’ needs and comply with

(patents, copyright, trademarks and trade secrets), employment

ever-changing regulatory requirements. In the context of public

disputes, corporate governance, securities, antitrust and

offerings and acquisitions, our attorneys handle the issues that

general commercial litigation. In addition to civil litigation,

regularly arise with equity plans or other employment benefit

our attorneys are experienced in representing clients in civil

arrangements.

and criminal government investigations. Using a network of
experienced local counsel, we routinely represent clients in

Intellectual Property Group

cases throughout the United States. To support our lawyers, we

We deliver comprehensive, integrated advice regarding all

have created a first-class litigation infrastructure of experienced

aspects of intellectual property protection and exploitation.

legal assistants and computerized litigation support systems

Fenwick & West has been consistently ranked as one of the

capable of handling everything from relatively small and simple

top five West Coast firms in intellectual property litigation and

cases to the largest and most complex “bet-the-company”

protection for the past 10 years by Euromoney’s Managing

mega-cases.

Intellectual Property publication. From providing sophisticated
legal defense in precedent-setting lawsuits, to crafting unique

Tax Group

license arrangements and implementing penetrating intellectual

Fenwick & West has one of the nation’s leading domestic and

property audits, our intellectual property attorneys have

international tax practices. The Tax Group’s unusually exciting

pioneered and remain at the forefront of legal innovation. We

and sophisticated practice stems from a client base that is

are continually in sync with our clients’ technological advances

represented in every geographic region of the United States,

in order to protect their positions in this fiercely competitive

as well as a number of foreign countries, and has included

marketplace.

approximately 100 Fortune 500 companies, 38 of which are in the
Fortune 100. In recent surveys of 1,500 companies published in

The Intellectual Property Group is comprised of approximately

International Tax Review, Fenwick & West was selected as one of

80 lawyers and other professionals. A significant number of the

only seven First Tier tax advisors in the United States.

lawyers in the group and other practice groups in the Firm have
technical degrees, including advanced degrees, and substantial
industry work experience. More than 35 attorneys are licensed
to practice before the U.S. Patent and Trademark Office. Our
lawyers’ technical skills and industry experience help us render
sophisticated advice with respect to novel technologies and
related intellectual property rights issues. Attorneys in the

Fenwick & West Offices

group have lectured and published widely on emerging issues

801 California Street

555 California Street

raised by the development, application and commercialization

Mountain View, CA 94041

San Francisco, CA 94104

of technology.

Tel: 650.988.8500

Tel: 415.875.2300

Litigation Group
Litigation is an unfortunate fact of life in business today. Our
Litigation Group has the range of experience and critical mass
to protect our clients’ interests in virtually any type of dispute,
large or small. We are experienced in all methods of alternative
dispute resolution and find creative ways to resolve cases
short of trial. However, we are trial lawyers first and foremost;
and the presence of our lawyers in a case signals to the other
side that we are ready and willing to try the case aggressively
and well, a message that itself often leads to a satisfactory
settlement. While we have extensive litigation experience in

www.fenwick .com

Samuel B. Angus is a partner in the Corporate Group of Fenwick &
West LLP, a law firm specializing in high technology matters. Mr. Angus
is resident in the San Francisco office and his practice concentrates on
the formation of start-up companies, venture capital and debt financings,
mergers and acquisitions, intellectual property licensing, joint ventures
and general corporate matters.
Mr. Angus represents a broad range of companies from privately held
start-up companies to publicly traded corporations. His practice also
includes advising entrepreneurs and investors.
Mr. Angus served as counsel for In-System Design, Inc. in connection
with its acquisition by Cypress Semiconductor Corporation. He also

Samuel B. Angus

counseled Naxon Corporation (Wineshopper.com) on its acquisition of
Wine.com, Inc., Micro Focus Group on its $500 million merger with

Partner
Corporate Group

Intersolve, Inc., Junglee Corp. on its $300 million acquisition by
Amazon.com, Inc., and Blue Lava Wireless on its $140 million acquisition
by JAMDAT Mobile. Among the clients Mr. Angus has represented are:

Phone: 415.875.2440
Fax:

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Ingenio, Inc.
(formerly Keen)

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Blue Lava Wireless
(acquired by JAMDAT Mobile)

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Adaptec, Inc.

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Junglee Corp.
(acquired by Amazon.com)

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Lightspeed Venture Partners
Khosla Ventures
Steamboat Ventures
Adteractive, Inc.

415.281.1350

E-mail: sangus@fenwick.com

Emphasis:
Start-Up/Venture-Backed
Companies

Revver, Inc.
JotSpot, Inc. (acquired by
Google)

ƒ
ƒ

Vibrant Media
@Home Corporation

Equity and Debt Financings

Mr. Angus received a Bachelor of Arts degree in law and society from

Mergers & Acquisitions

the University of California at Santa Barbara. He received a J. D. from
University of California Hastings College of the Law in 1993. At

Securities Matters
Intellectual Property Licensing

Hastings, he was the Executive Articles Editor for the Hastings
International and Comparative Law Review. Mr. Angus is a member of
The Bar Association of San Francisco, the State Bar of California and
the American Bar Association. Prior to joining Fenwick & West, Mr.
Angus practiced commercial lending law at the law firm of Lillick &
Charles. Prior to becoming a lawyer, Mr. Angus was a founder and the
chief executive officer of Design Look Publications, Inc., an international
publisher of fine art calendars and other published gift products.
Mr. Angus sits on the advisory board of the Lester Center for
Entrepreneurship & Innovation at the University of California, Berkeley.
He is also a frequently lecturer at the HAAS School of Business and the
Stanford Technology Ventures Program.

Narinder S. Banait is of counsel in the Intellectual Property Group
of Fenwick & West LLP, a law firm specializing in technology and life
sciences matters. Fenwick & West is headquartered in Mountain View
and San Francisco, California.
Dr. Banait has legal, and technical experience representing companies
in pharmaceutical, biotechnology, and high technology areas that
include

pharmaceuticals,

polymer

based

inks,

photomasks,

nanotechnology, chip manufacture, microfluidics, microarray, and
genomics. Dr. Banait has represented clients including:

Narinder S. Banait, Ph.D.
Of Counsel

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AGY Therapeutics
Admunex Therapeutics
Agilent Lifesciences
Granite Global Ventures

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Incyte Genomics
Iconix
Quantum Dots
Vanguard Ventures

Intellectual Property Group

Dr. Banait has published over a dozen scientific papers in peer reviewed
Phone: 650.335.7818

journals. In addition, he has written and prosecuted patent applications
related to polymers, peptides, carbon nanotubes, photochemistry,

Fax:

650.938.5200

chemical processes and method of manufacture, small molecule and

E-mail: nbanait@fenwick.com

oligonucleotide drug candidates for the treatment of CNS disorders,
telomerase inhibitors, treatment for cancer and osteoporosis, and

Emphasis:
Patent Prosecution
Patent Analysis
Patent Counseling

applications on synthetic methods.
Organization and Community Participation

ƒ American Bar Association
ƒ California Bar Association
ƒ EPPIC

Patent Litigation

Dr. Banait received his undergraduate education at University of

Intellectual Property Due Diligence

Toronto, graduating with a B.S. in chemistry and biochemistry. He
received a M.S. in synthetic chemistry and a Ph.D. in organic chemistry,
both from the University of Toronto. Dr. Banait was a Post-doctoral
fellow at Brandeis University, and at University of California. In addition,
he worked as a research scientist at Syntex Research, a pharmaceutical
company that was acquired by Roche, where he primarily focused on 5HT3 antagonists for the treatment of emesis and anxiety disorders. He
received his J.D. from the Santa Clara University in 1997.
Dr. Banait is a member of the State Bar of California and is registered to
practice before the U.S. Patent and Trademark Office.

Fred M. Greguras is of counsel in the corporate and technology
transactions groups at Fenwick & West LLP, a law firm specializing in high
technology matters. He practices out of the firm’s Mountain View, California,
office. Mr. Greguras focuses on strategic legal issues for software,
semiconductor-related and life sciences companies. His practice includes
start-up issues and financings in both domestic and international
transactions. He has represented a wide range of companies in financing,
M&A, licensing and other commercial transactions, from privately held startups to publicly traded companies. Mr. Greguras has also been a venture
capitalist and a general counsel and CFO for a startup. Some of the clients
he has represented are:

Fred M. Greguras
Of Counsel
Corporate and Technology
Transactions Practice Groups

ƒ BioMarker Pharmaceuticals, Inc.
ƒ Excite@Home
ƒ Exodus Communications, Inc.
ƒ Kintana, Inc.
ƒ Speedera Networks, Inc.
Mr. Greguras has authored many articles on start-up, financing,

Phone: 650.335.7241
Fax:

650.938.5200

E-mail: fgreguras@fenwick.com

outsourcing, Internet and international legal issues, which are available at
www.fenwick.com.
He received a Bachelor of Arts in mathematics from University of
Omaha in 1966, a Masters of Science in mathematics and computer

Emphasis:

science in 1968, and his J.D. in 1975 from the University of Nebraska.
Mr. Greguras is a member of the State Bar of California.

Startups and Venture Capital
Financings
Licensing
Intellectual Property Protection

Gaurav Mathur is an associate in the Litigation Group of Fenwick &
West LLP, a law firm specializing in technology and life sciences matters.
Fenwick & West is headquartered in Mountain View, California, with an
office in San Francisco. Mr. Mathur’s practice focuses on intellectual
property litigation.
Mr. Mathur received his J.D. from Northwestern University School of Law,
Chicago in 2005. He received his B.S. in chemical engineering and
Business Foundations Certificate from the University of Texas at Austin,
in 2001.
Mr. Mathur is a member of the State Bar of California.

Gaurav Mathur
Associate
Litigation Group

Phone: 650.335.7158
Fax:

650.938.5200

E-mail: gmathur@fenwick.com

Emphasis:
Litigation

Tahir J. Naim is an associate in the Corporate Group of Fenwick &
West LLP, a law firm specializing in high technology matters. Fenwick &
West has offices in Mountain View and San Francisco, California. Mr.
Naim’s practice focuses on executive compensation, stock plans and
ERISA issues as they arise in mergers, hirings, layoffs, benefits
administration and the general course of business. Among the clients he
has represented are:

Tahir J. Naim
Associate
Corporate Group

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Barclays Global Investors, N.A.
Cisco Systems, Inc.
DexCom, Inc.
Diamond Foods, Inc.
Intuit Inc.

Mr. Naim received his undergraduate education at Macalester College, St.
Paul, graduating with a B.A. in political science in 1987. He attended law
school at Golden Gate University (in part on a Rensch Scholarship for

Phone: 650.335.7326
Fax:

650.938.5200

E-mail: tnaim@fenwick.com

persuasive writing), graduating with a J.D. in 1992. Mr. Naim received his
LL.M. (Tax) from Golden Gate University, with an emphasis on benefits
and executive compensation, in 1995.
Mr. Naim is a member of the Santa Clara County Bar Association, the
South Asian Bar Association of Northern California, the Asian Pacific Bar

Emphasis:

Association of Silicon Valley and the Asian American Bar Association of

ERISA

Greater Bay Area.

Executive Compensation
Mergers and Acquisitions

Experiences and Accomplishments

ƒ

Drafter of State Bar of California Conference of Delegates
proposal to amend Cal. Corp. Code Sec. 25102(o) to ease stock

Stock Plans

administration. Testified before Assembly and Senate committees
in favor of bill’s passage. The bill passed without opposition and
became law January 1, 2002.

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Law Clerk in the Environmental Enforcement Section of the U.S.
Dept. of Justice.

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Two-term President of the South Asian Bar Association of
Northern California.

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One of several organizers/sponsors of the 2003 Conference of the
Indo-American Leadership Initiative.

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Legal Clinic Volunteer through the Santa Clara County Bar
Association.

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2004 Chair of the Minority Access Committee of the Santa Clara
County Bar Association.

Articles

ƒ

"Another 409A-Related Deadline: California Developments Linked
to

Backdated

Options

and

Section

409A,"

Tahir

Naim,

TheCorporateCounsel.net, March 5, 2007.

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"The NEO Changes—Effect on Code Section 162(m) Covered
Executives?", Tahir Naim, The Corporate Executive, pgs. 8-9,
September-October 2006. Law Clerk in the Environmental
Enforcement Section of the U.S. Dept. of Justice.

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"Time to Share: A Basic Guide to Stock Options in China", Tahir
Naim, The Recorder: Doing Business in China supplement guide,
July 24, 2006.

ƒ

Contributor to "Statutory Stock Options" vol. 381-2nd of the Tax
Management Portfolio series published by the Bureau of National
Affairs, 2001 (a later edition has since been published to which Mr.
Naim did not make an additional contribution, though his prior work
continues to be incorporated therein).

2

Rajiv P. Patel is a partner in the Intellectual Property Group of Fenwick
& West LLP. His practice includes patent portfolio development and
management, patent enforcement, and patent and high technology
transactions. His practice also includes intellectual property (“IP”) audits
and strategies to help companies identify, evaluate and protect key
intellectual assets.

Rajiv P. Patel
Partner
Intellectual Property Group

Phone: 650.335.7607
Fax:

650.938.5200

E-mail: rpatel@fenwick.com

Emphasis:

In patent portfolio development and management, Mr. Patel has
counseled, prepared and prosecuted patents in a wide range of technology
areas including wireless communications, electronics, network processors,
complex hardware architecture, complex software architecture, electromechanical devices, and business methods. He has advised and initiated
patent reissue and reexamination strategies and proceedings. He has also
partaken in appeals before the Board of Patent Appeals and Interferences.
In addition, Mr. Patel is active in developing and overseeing strategies
involving foreign patent prosecution and procurement, including for Europe,
Japan, China, Taiwan, and India.
In patent enforcement, Mr. Patel litigated in technology areas that include
solid-state memories, electronic gaming, Internet delivery networks, and
interactive television. In patent and IP transactions, he has negotiating
large patent and other IP portfolios, evaluated IP portfolios for acquisition,
and conducted diligence for venture funding, mergers & acquisitions, and
initial public offerings.
Among the clients Mr. Patel has represented are:

Patent Counseling
Patent Analysis
Patent Prosecution
Patent Litigation
Intellectual Property Counseling
Intellectual Property Licensing
Intellectual Property Audits
Intellectual Property Due Diligence

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Logitech, Inc.
Compuware Corporation
Fujitsu Ltd.

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Magma Design Automation
Plaxo, Inc.
Canon Research Americas, Inc.

Mr. Patel is an Adjunct Professor of Law at the University of California,
Hastings College of the Law where he teaches a course on patents. Mr.
Patel is also on the faculty of Practising Law Institute and Law Seminars
International. In addition, Mr. Patel has authored articles in the field of
patent and IP portfolio development and management strategies.
Mr. Patel received his Bachelor of Science (with high honors) in Electrical
Engineering from Rutgers University (NJ). He received his Juris Doctor and
Master of Intellectual Property from Franklin Pierce Law Center (NH). He is
a member of the California Bar and is registered to practice before the U.S.
Patent and Trademark Office.

Rajiv P. Patel

Highlighted Legal Experience:
Patent Strategy and Portfolio Development

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ƒ
ƒ

ƒ

ƒ

ƒ

Created patent strategy and developing patent portfolio for $500
million plus product line of a computer peripheral manufacturer.
Created patent strategy and advised on patent portfolio for on-line
auction company. Patent portfolio sold for over $750,000.
Evaluated patent portfolio for nanotechnology company in
conjunction with industry trends and directions in new technology
space where company was shifting focus to and advise on new
patent strategy.
Developing patent strategy and foundational patent portfolio for startup and early stage and start-up companies in technology fields such
as network storage, business process software, and web services.
Developing and managing patent portfolio for emerging mid-size and
large companies in technologies fields such as electronic design
automation, processor technology, wireless data communications,
optical data processing, and enterprise software tools.
Sample Patents:
• U.S. Patent No. 6,246,294 Supply Noise Immunity Low-Jitter
Voltage-Controlled Oscillator Design
• U.S. Patent No. 5,909,151 Ring Oscillator Circuit
• U.S. Patent No. 5,948,083 System and Method for SelfAdjusting Data Strobe
• U.S. Patent No. 5,748,126 Sigma-Delta D/A Conversion
System and Process Through Reconstruction and Resampling
• U.S. Patent No. 5,991,296 Crossbar Switch with Reduced
Voltage Swing and No Internal Blocking Path
• U.S. Patent No. 6,055,629 Predicting Branch Instructions in a
Bunch Based on History Register Updated Once
• U.S. Patent No. 6,052,033 Radio Frequency Amplifier System
and Method
• U.S. Patent No. 5,835,852 Integrated Electronic
Communication Device and Clip
• U.S. Patent No. 6,389,405 Processing System for Identifying
Relationships Between Concepts
• U.S. Patent No. 5,995,955 System and Method for Expert
System Analysis Using Quiescent and Parallel Reasoning and
Set Structured Knowledge Representation
• U.S. Patent No. 6,275,622 Image Rotation System
• U.S. Patent No. 6,246,016 Optical Detection System, Device,
and Method Utilizing Optical Matching

Rajiv P. Patel

Highlighted Legal Experience:
Patent and Intellectual Property Transactions

ƒ

ƒ
ƒ
ƒ

Led intellectual property audit for Fortune 500 communication
company’s intellectual property in wireless technology and advised
on intellectual property issues in context of tax framework.
Led intellectual property audit for electronic gaming company and
developed intellectual property management structure for company.
Conducted numerous intellectual property due diligence for hightechnology investments by venture capital companies.
Conducted numerous intellectual property due diligence on behalf of
target companies or acquirer companies in high-technology merger
and acquisition matters.

Patent Litigation

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ƒ
ƒ
ƒ

ICTV, Inc. v. Worldgate Communications, Inc. – advised on patent
litigation strategy in interactive television market.
SanDisk Corporation v. Lexar Media, Inc. – patent litigation involving
flash memory consumer products.
GameTech International, Inc. v. Bettina Corporation – patent
litigation involving electronic gaming.
Planet Bingo, LLC v. GameTech International, Inc. – patent litigation
involving casino style games on electronic devices.
Akamai Technologies, Inc. v. Speedera Networks, Inc. – patent
litigation involving Internet content delivery services.

Teaching Experience

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ƒ

ƒ
ƒ
ƒ

Adjunct Professor of Law for “Patent Practice” at University of
California, Hastings College of the Law (2001 to present).
Faculty Member for Practising Law Institute for “Advanced Patent
Prosecution,” “Fundamentals of Patent Prosecution,” and “Patent
Law for the Non-Specialist” courses (2002 to present).
Faculty Member for Law Seminars International for “Defending
Against Patent Infringement Claims” (2004).
Course Instructor in “Laws and Emerging Technology” for O’Reilly
Emerging Technologies Conference (April 2003).
Course Instructor in “Intellectual Property Strategies and
Management for Federal Publication Seminars (May 2002).

Rajiv P. Patel

Publications

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ƒ

ƒ

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ƒ

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Software Escrows as Part of an Intellectual Property Strategy,”
Computer Law Association First Asian Conference, Bangalore, India,
2005.
“Underutilized Patent Reexaminations Can Improve Business
Strategy,” Daily Journal, Vol. 110, No. 75, April 19, 2004.
“Software Outsourcing Offshore – Business and Legal Issues
Checklist,” SHG Software 2004 Conference, 2004.
“A Strategic Look at the Final Rejection,” Advanced Patent
Prosecution Workshop, Practising Law Institute, No. G0-10A8, 2003
- 2005.
”Understanding After Final and After Allowance Patent Practice,”
Fundamentals of Patent Prosecution, Practising Law Institute, No.
G0-01EV, 2003 -2005.
“Think Value, Not Cheap, For Long-Term Success,” Succeeding with
New Realities, TiEcon 2003, Published by TiE Silicon Valley 2003.
“The Intellectual Property Audit,” Building and Enforcing Intellectual
Property Value, An International Guide for the Boardroom 2003,
Published by Globe White Page 2002.
“Patent Portfolio Strategy for Start-Up Companies: A Primer,” Patent
Strategy and Management, Vol. 3, No. 7, Nov. 2002.
“Potent Portfolio,” Daily Journal, Vol. 106, No. 244, Dec. 15, 2000.
“Own Idea,” Daily Journal, Vol. 105, No. 10, Jan. 15, 1999.
“Disclose Lite,” Daily Journal, Vol. 103, No. 55, Mar. 21, 1997.

Organization and Community Participation

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American Bar Association
American Intellectual Property Law Association
TiE (“The Indus Entrepreneurs” / “Talent, Ideas, Enterprise”)
Computer Law Association
Dean’s Leadership Council for Franklin Pierce Law Center
Dean’s Committee for Rutgers University, School of Engineering

Sayre E. Stevick is a partner in the Corporate Group of Fenwick &
West LLP, a law firm specializing in high technology matters. Mr. Stevick
practices out of the firm’s Mountain View, California, office. His practice
concentrates on the representation of high technology companies on a
variety of transactions, including venture capital financings, mergers and
acquisitions and public offerings.

Mr. Stevick’s practice also includes

providing day-to-day counseling to such companies (and their boards of
directors) on numerous other corporate matters. Mr. Stevick also
represents various investors and underwriters. The following are among
the clients he has represented:

Sayre E. Stevick
Partner
Corporate Group

Phone: 650.335.7868
Fax:

650.938.5200

E-mail: sstevick@fenwick.com

Emphasis:
VC Financings
Mergers and Acquisitions
Public Offerings

ƒ Accel Partners
ƒ Cisco Systems, Inc.
ƒ Crosspoint Venture Partners
ƒ Digeo, Inc.
ƒ eBates.com
ƒ E-Tek Dynamics, Inc.
ƒ Foundation Capital
ƒ Goldman, Sachs & Co.
ƒ Good Technology, Inc.
ƒ InterWest Partners
ƒ Keyhole Corporation (developer of “Google Earth”)
ƒ Kintana, Inc. (acquired by Mercury Interactive Corporation)
ƒ Kleiner Perkins Caufield & Byers
ƒ Luxtera, Inc.
ƒ MarketWatch.com, Inc.
ƒ Mendocino Software, Inc.
ƒ NetScreen Technologies, Inc.
ƒ Peribit Networks, Inc. (acquired by Juniper Networks)
ƒ Proofpoint, Inc.
ƒ RGB Networks, Inc.
ƒ Stanford Research Institute
ƒ Tellme Networks
ƒ Torrent Networking Technologies Corp. (acquired by Ericsson Inc.)
ƒ Visage Mobile, Inc.
Mr. Stevick received his undergraduate education at the University
of California at Berkeley, graduating with a B.A. degree in political
science in 1990. He attended law school at the University of
California, Hastings College of the Law where he was a member of
the Thurston Honor Society and the Order of the Coif, graduating
second in his class and magna cum laude in 1997.

Notes:

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